S&P 500 & Sectors: Free Cash Flow Yield Posts Quarterly Decline in 2Q22

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The free cash flow (“FCF”) of the S&P 500[1],[2] remains above average on a rolling basis, but a drop in FCF yield is alarming given the economic downturn companies are facing.

This report is an abridged version of S&P 500 & Sectors: Free Cash Flow Yield Shows Quarterly Declines in 2Q22, one of our quarterly fundamental market and sector trends series.

FCF Yield Falling Aft in 2Q22

The FCF yield of the S&P 500 fell from 2.25% on 6/30/22 to 2.04% on 8/12/22.

Only four sectors of the S&P 500 saw an increase in FCF performance back from 6/30/22 to 8/12/22.

Key details on selected S&P 500 sectors

With an FCF yield of 11.2%, investors are getting more FCF for their investment dollar in the telecommunications services sector than in any other sector as of 12/8/22. On the other hand, the real estate sector, at -4.4%, currently has the lowest FCF yield of any sector in the S&P 500.

The Telecom Services, Energy, Real Estate and Healthcare sectors each saw an increase in FCF performance from 6/30/22 to 8/12/22.

Below, we highlight the telecommunications services sector, which saw the strongest year-over-year improvement in FCF performance.

Example of sector analysis: Telecom Services

Figure 1 shows that the mobile FCF return for the telecommunications services sector increased from -0.9% on 9/30/21 to 11.2% on 8/12/22. FCF of the telecommunications services sector increased from -$14.0 billion in 2Q21 to $147.7 billion in 2Q22, while the value of the company increased from $1.6 trillion in 30/ 09/21 to $1.3 trillion as of 08/12/22.

Figure 1: Telecom Services FCF Return: December 2004 – 8/12/22

S&P 500 Telecommunications Services Sector 2Q22 FCF Return

S&P 500 Telecom Services Sector FCF Yield 2Q22 (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The August 12, 2022 measurement period uses price data as of that date and incorporates 2Q22 10-Q financial data, as this is the earliest date for which all 2Q22 10-Qs for components of the S&P 500 were available.

Figure 2 compares FCF and enterprise value trends for the telecommunications services sector since 2004. We sum the individual S&P 500/sector constituent values ​​for free cash flow and enterprise value. We call this approach the “Aggregate” methodology, and it matches the S&P Global (SPGI) methodology for these calculations.

Figure 2: Telecom Services FCF and Enterprise Value: December 2004 – 8/12/22

S&P 500 Telecom Services Sector FCF and Enterprise Value 2Q22

S&P 500 Telecom Services Sector FCF and Enterprise Value 2Q22 (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The August 12, 2022 measurement period uses price data as of that date and incorporates 2Q22 10-Q financial data, as this is the earliest date for which all 2Q22 10-Qs for components of the S&P 500 were available.

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

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

Figure 3 compares these three methods of calculating the rolling FCF returns of the telecommunications services sector.

Figure 3: FCF Yield Methodologies of Telecom Services Compared: December 2004 – 8/12/22

2Q22 S&P 500 Telecommunications Services Sector FCF Performance Analysis

FCF Performance Analysis of S&P 500 2Q22 Telecom Services Sector (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The August 12, 2022 measurement period uses price data as of that date and incorporates 2Q22 10-Q financial data, as this is the earliest date for which all 2Q22 10-Qs for components of the S&P 500 were available.

This article originally published on August 25, 2022.

Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Brian Pellegrini 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

We derive the above measures by summing the individual S&P 500/sector constituent values ​​for Free Cash Flow and Enterprise Value to calculate the FCF return. We call this approach the “Aggregate” methodology.

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

For additional perspective, we compare the Aggregate method for free cash flow with two other market-weighted methodologies. These market-weighted methodologies add more value to ratios that do not include market values, for example, ROIC and its drivers, but we include them here nonetheless for comparison:

  1. Market-weighted measures – calculated by market capitalization weighting the return of FCF for individual companies relative to their sector or the entire S&P 500 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 S&P 500/its sector
    2. We multiply each company’s FCF yield by its weight
    3. The FCF return of the S&P 500/sector is equal to the sum of the weighted FCF returns of all the companies in the S&P 500/sector
  2. 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 S&P 500/its sector
    2. We multiply each company’s free cash flow and enterprise value by its weight
    3. We add the weighted FCF and the weighted enterprise value for each S&P 500 company/each sector to determine the weighted FCF and the weighted enterprise value for each sector.
    4. The return of the S&P 500/sector backward FCF is equal to the S&P 500/sector FCF weighted by the weighted enterprise value of the S&P 500/sector

Each methodology has its pros and cons as listed below:

Aggregate method

Advantages:

  • A direct view of the entire S&P 500/sector, regardless of company size or weighting.
  • 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:

  • Considers a company’s market capitalization relative to the S&P 500/sector and weights its metrics accordingly.

The inconvenients:

  • Vulnerable to outlying results that disproportionately impact overall FCF performance.

Market-weighted factor method

Advantages:

  • Considers a company’s market capitalization relative to the S&P 500/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.

[1] We calculate these measures based on the S&P Global methodology, which sums individual S&P 500 values ​​for market capitalization and economic book value before using them to calculate the measures. This is what we call the “Aggregate” methodology.

[2] Our research is based on the latest audited financial data, which is 2Q22 10-Q for most companies. Price data is as of 8/12/22.

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