Free cash flow yield close to record levels through 05/16/22

0

Free cash flow (FCF) for the NC 2000 remains elevated, relative to recent quarters, as stock prices fall more than FCF. I think the market is signaling expectations for further declines in FCF, and I expect prices to continue lower until the end of the FCF declines is in sight.

This report is an abbreviated version of All Cap Index & Sectors: Free Cash Flow Yield Near Record High Through 5/16/22, one of my quarterly reports on fundamental market and sector trends. This research is based on the latest audited financial data, which is 1Q22 10-Q in most cases. Price data is as of 05/16/22.

NC 2000 Trailing FCF Yield increases over past year

The FCF yield of the NC 2000 fell from 1.2% on 6/30/21 to 1.7% on 5/16/22. The FCF yield of the NC 2000 has only been as high two other times since 2015: 6/30/16 and 12/31/18.

Eight NC 2000 sectors saw an increase in FCF yield from 6/30/21 to 5/16/22,

Key details on certain CN 2000 sectors

With an FCF yield of 4.2%, investors are getting more FCF for their investment dollar in the basic materials sector than in any other sector as of 5/16/22. On the other hand, the industrials sector, at -0.9%, currently has the lowest FCF yield of any NC 2000 sector.

The Telecom Services, Energy, Utilities, Financials, Real Estate, Healthcare, Consumer Staples and Basic Materials sectors each saw an increase in Mobile FCF performance from 06/30/21 to 05/16/22.

Below, I highlight the FCF performance of the energy sector.

The full version provides the same details for each sector as this report for the energy sector.

Sector Analysis Example: Energy

Figure 1 shows that the FCF yield of the energy sector increased from 0.7% on 6/30/21 to 4.0% on 5/16/22. Energy sector FCF increased from $16.8 billion in 1Q21 to $123.2 billion in 1Q22, while enterprise value increased from $2.3 trillion as of 6/30 /21 at $3.1 trillion as of 5/16/22.

Figure 1: Energy FCF yield: December 1998 – 05/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs for NC 2000 constituents were available.

Figure 2 compares FCF and enterprise value trends for the energy sector since 1998. I sum the individual NC 2000/sector constituent values ​​for free cash flow and enterprise value. I call this approach the “global” methodology, and it matches the S&P Global (SPGI) methodology for these calculations.

Figure 2: FCF Energy and Enterprise Value: December 1998 – 5/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs for NC 2000 constituents were available.

The Aggregate Methodology provides a simple view of the entire NC 2000/sector, regardless of market capitalization or index weighting, and is the way S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for free cash flow with two other market-weighted methodologies. Each method has its advantages and disadvantages, which are detailed in the appendix.

Figure 3 compares these three methods of calculating rolling FCF returns for the energy sector.

Figure 3: Back FCF Energy Efficiency Methodologies Compared: December 1998 – 5/16/22

The May 16, 2022 measurement period uses price data on that date and incorporates financial data from 1Q22 10-Qs, as this is the earliest date for which all 1Q22 10-Qs for NC 2000 constituents were available.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, style, or theme.

Annex: Analysis of the final yield of the FCF with different weighting methodologies

I get the above metrics by adding the individual NC 2000/sector constituent values ​​for free cash flow and enterprise value to calculate the final FCF yield. I call this approach the “Aggregate” methodology.

The Aggregate Methodology provides a simple view of the entire NC 2000/sector, regardless of market capitalization or index weighting, and is the way S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for free cash flow with two other market-weighted methodologies. These market-weighted methodologies add more value for ratios that don’t include market values, e.g. ROIC and its drivers, but I’m including them here nonetheless, for comparison:

Market-weighted measures – calculated by weighting by market capitalization the FCF return of individual companies relative to their sector or the aggregate NC 2000 in each period. Details:

  1. The weight of the company is equal to the market capitalization of the company divided by the market capitalization of the NC 2000/its sector
  2. I multiply the FCF yield of each company by its weight
  3. The yield in FCF NC 2000/sector is equal to the sum of the yields in weighted FCF for all companies in NC 2000/sector

Market-weighted drivers – calculated by weighting by market capitalization the FCF and the enterprise value for the individual companies of each sector in each period. Details:

  1. The weight of the company is equal to the market capitalization of the company divided by the market capitalization of the NC 2000/its sector
  2. I multiply each company’s free cash flow and enterprise value by its weight
  3. I sum the weighted FCF and the weighted enterprise value of each NC 2000 company/each sector to determine the weighted FCF and the weighted enterprise value of each sector
  4. The yield of the NC 2000 FCF/sector is equal to the weighted FCF NC 2000/sector divided by the weighted enterprise value NC 2000/sector

Each methodology has its pros and cons as listed below:

Aggregate method

Advantages:

  • A simple look at the whole NC 2000/sector, whatever the size or weight of the company
  • Corresponds to how S&P Global calculates metrics for the S&P 500.

The inconvenients:

  • Vulnerable to the impact of companies entering/leaving the corporate group, which could unduly affect overall values. Also sensitive to outliers over a period of time.

Market-weighted measures method

Advantages:

  • Takes into account a company’s market capitalization relative to the NC 2000 sector and weights its measures accordingly.

The inconvenients:

  • Single company outlier-vulnerable results have a disproportionate impact on overall FCF performance.

Market-weighted factor method

Advantages:

  • Considers a company’s market capitalization relative to the NC 2000 sector and weights its free cash flow and enterprise value accordingly.
  • Mitigates the disproportionate impact of a company’s outlying results on overall results.

The inconvenients:

  • More volatile as it emphasizes large changes in FCF and enterprise value for heavily weighted companies.
Share.

Comments are closed.