A purer measure: Cash flow yield
Free cash flow yield is a company’s free cash flow per share compared to a company’s stock price per share. Free cash flow for this calculation is cash flow from operations less capital expenditures. Share price is the market price. Both the numerator and the denominator are divided by the number of shares outstanding. It connects the company’s free cash flow generation and the market price in terms of yield—how much free cash flow a company is generating compared to the price of one share of its stock. We’ve included Ford (F), General Motors (GM), and Volkswagen (VOW). We excluded the BMW Group (BMW) as it is cash flow negative in the past year. Alternatively, one could invest in the exchange-traded fund CARZ.
As you can see from the chart above, Ford’s free cash flow yield is increasing and is currently at 9.6. This is from the numerator increasing—free cash flow is increasing. The denominator—the market value per share of has been fairly stable. With Ford’s recent buyback announcement, the potential dilution from management incentives and the conversion of a convertible bond are offset to maintain the number of shares outstanding. As we’ve seen, Ford is generating free cash flow even as it’s investing billions into R&D (research and development) for new products, rationalizing its manufacturing footprint, and has significant market share in the leading economies. Interestingly, VOW’s free cash flow yield declined in the past three months, while the rest of the industry—General Motors , Ford, and Toyota (TM)—increased. Overall, you can invest in the exchange traded fund CARZ.
Down the road
As the economic cycle expands, the investments by F, GM, TM, BMW, and VOW should begin to convert to free cash flow in 2015 and 2016. Share prices should remain fairly consistent across the industry, as the growth is self financed, meaning the R&D and manufacturing realignments in the industry are paid for from internally generated cash flow and not by cash raised from the markets. Without this need for external financing, equity levels should be stable.
Context for free cash flow yield
It is valuable to point out that free cash flow yields can be volatile with cyclical companies. For example, as BMW was generating cash, but the market crashed, BMW’s free cash flow yield went to 50, and it’s now negative and not included in the table above due to the negative value. What that’s saying is BMW is not generating free cash flow, as it’s preparing for its next generation vehicles. As you recall from a prior chart, BMW is spending R&D dollars equivalent to companies selling six+ million, while it’s selling approximately two million per year. Similarly, Ford’s free cash flow yield was negative in 2009.