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What is Free Cash Flow (FCF) | Free Cash Flow yield | Stock market for beginners - YouTube

Channel: Groww

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hey guys welcome to another episode with

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me shashank udupa and in today's episode

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i'm gonna talk to you about free cash

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flow yield yes now free cash flow yield

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is like a new topic that we're gonna

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talk about and we're gonna understand

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what free cash flow yield is so don't

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worry about it i'm gonna break down

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everything for you in very simple parts

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in the entire video but what we're gonna

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do today is we're gonna find out the

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definition of free cash flow yield we're

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going to find out how to calculate fcf

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which is also known as free cash flow

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we're going to understand what is cash

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flow from operations also known as cfo

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and we're going to understand its

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correlation with capex which is capital

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expenditure we're also going to look at

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fcf yield and earnings yield and finally

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i'm also going to show you a few

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examples and then conclude so it's going

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to be a power pack knowledge episode so

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we're going to start this asap

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[Music]

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now what is the definition of free cash

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flow right now free cash flow yield is

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basically the free cash flows of a

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business whatever the business can

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produce free cash flow produce against

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its current market value so

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mathematically if i put in mathematical

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terms free cash flow yield is basically

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free cash flows divided by the total

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market value of the company or it is

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also like free cash flow per share

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divided by the current market price of

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the share now this is the mathematical

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formula but you need to understand the

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logic behind it the logic behind it

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basically says if there's a company that

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is operating and it has free cash flow

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that all the money is free what is it

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valued against its current market price

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now we'll understand more about what

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free cash flows are in the next segment

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now what are free cash flows now free

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cash flow is in any financial year in

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any given financial year if a business

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can generate any amount of cash after

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removing all its expenses right that is

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known as free cash flow so basically any

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cash flow any cash generated from

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operations any cash that is generated

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from doing the business after removing

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all the other expenses like capital

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expenditure of the year that is known as

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free cash flow now cash flow generated

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from operations right mother doing

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operating activity is basically known as

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cash flow from operations or which we

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also look at called as cfo cash flow

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from operations now this basically takes

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into all the cash that is coming and

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that is being generated by the business

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activity now it includes operating cash

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income and cash expenses so let me give

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you an example only the sales that

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happen in a particular year are taken

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into account similarly same way only the

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expenses that happens in cash are taken

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into account as well now by the way in

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accounting terms there are some non-cash

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accounting terms as well so the non-cash

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items are basically like depreciation or

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goodwill amortization now these things

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won't be a part of the cash flow

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statement because cash is physically not

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going out of the company now they would

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form a part of the cash flow statement

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but they do not impact the cash flows so

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depreciation and good will form a part

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of the cash flow but they don't impact

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the cash flow now there's another thing

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called cash flow from investing or

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financing so basically any cash flow

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that is coming from investing or

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financing will not be a part of cash

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flow from operations which is cfo so

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actually if you look at it there are

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three types of cash flow one is cash

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flow from operating activities or

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operations cfo then we have cash flow

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from investing activities which is cfi

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and we have cash flow from financing

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activities also so there are three

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different type of cash flows if the

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business is basically taking a loan or

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it's making an investment into the

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equity market or the debt market it

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won't come under cash flow from

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operations it will come under cash flow

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of investing okay so just to make it

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clear for you how to understand this now

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if you understand what cash flow from

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operation is free cash flow okay minus

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kpex right now if you have a fair id of

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cfo which is cash flow from operator

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understand that free cash flow is

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nothing but the cash flow from

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operations minus the capex and what is

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kpex now kpek's full form is basically

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known as capital expenditure now capital

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expenditure is basically the investment

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a business does to acquire upgrade

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maintain its physical assets or property

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plant building technology equipment

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anything like that that is known as kpex

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so when you deduct this capex from the

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cash flow from operations which is cfo

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you get the fcf fcf is basically free

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cash flow means all the money that i

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made in a year i remove my capex which

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is basically investing or upgrading or

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maintenance of plants all that is done

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usakebad whatever money that i have that

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is known as free cash flow now each

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business's aim is to get as much free

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cash flow as possible because if this

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free cash flow is a lot for a business

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they can use this in the future to

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invest or do a share buyback or maybe

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give a lot of dividends bonus all this

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is important so that is why a company

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that is focusing on free free cash flow

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which is fcf a greater amount is better

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and if the company does it i mean if the

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company goes negative fcf it is

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considered bad right so ideally it

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should just be uh positive fcf and

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obviously here the greater the amount of

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fcf that they can maintain like higher

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cash flow free cash flow the market

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value of the company will also keep

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going up so this is why fcf for free

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cash flow is very important now let's

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understand what is free cash flow yield

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versus earnings yield now for that we

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need to understand how you calculate

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free cash flow yield now we know what

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free cash flow is right now free cash

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flow yield if you calculate fcf yield it

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is basically calculated by dividing the

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free cash flow by the market value of

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the company now earnings yield is

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basically calculated by dividing the

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earnings by the market value of the

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company now why is this important right

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now you will be like isn't earnings

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yield better than fci field why are we

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even looking at fcf field now fcf yield

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is apparently considered a better metric

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to estimate than earnings yield and the

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reasons why fcf yield is considered

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better is because the value of any

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business is discounted value of cash

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flow that it generates over a period of

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time right if the company is going to

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generate a lot of cash flow in the next

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five years then the value of the

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business can be determined by something

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like that now earnings often hides the

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strength and weaknesses of a company

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whereas cash flow cannot hide the

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strength and weaknesses of a company

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because i know exactly how much money is

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coming in and how much money is going

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out so you can't hide from that element

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now cash flows are the best indicator of

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how well a business is run the business

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can make a lot of revenues okay they can

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make a lot of revenue a lot of net

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profit but if that is not being visible

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in the cash flow and at the end of the

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day the company is not being cash flow

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positive then it becomes a slight a

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problem for the company and slight

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problem for us as well but now let's try

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to understand which industries we can

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use fcf yield and where does it work and

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where it doesn't work because there are

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some industries that are very capex

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heavy they have to invest a lot so that

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there the fcf yield might not work now

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if you look at any industry like fmcg

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consumption it and it services you will

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see positive cash flow is there over a

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long period of time why because in these

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companies the amount of revenue that

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they generate they don't have to put so

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much back inside like for example in the

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id space the majority of the revenue or

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the expenses for it is basically their

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employees right it is manpower employees

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so now but in fmcg yes there is a

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certain amount of capex but one capex

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investment can give a massive amount of

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return over the long period of time now

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if you look at other industries like

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steel industry iron ore sugar and all

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these cyclical industries kpix

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requirement is very high right you have

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to invest a lot in capex and that is why

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fca yield metric will not work for them

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let me show you infosys example now if

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you look at infosys over a long period

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of time you will see that the cash flow

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from operating activity at the end is

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around 23 000 crores whereas if you look

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at the cash flow from investing

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activities it is approximately around 7

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300 crores now if you see this

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towards the end you will see that the

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cash flow from operations is

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significantly higher than cash flow from

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investing that means capex related

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investments are a part of the cfi and we

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can see from this that the cfo is so

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high the operation cash flow is so high

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from the cfi which is uh cash flow from

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investing activity that means it is

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comparatively good for us because now

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they can make a lot of free cash flow

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why because free cash was nothing but

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cash flow from operations minus the uh

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kpx right now if you check the details

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infosys has a negligible capex

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investment at this fi 21 year so if you

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look at that cash flow from investing

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activity is 7 300

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but if you look at all that investments

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purchase and investment sold it's

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basically negligible it is not something

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very big so this is why it is very

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important for us to understand that if a

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company is making a lot of free cash

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flow from operations and less expenses

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it is good for us over a long period of

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time now the same way if you look at

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this fcf is basically cfo minus apex so

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if you look at it from info systems 23

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000 crores okay minus 2 100 crores 23

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000 crores was the cash flow from

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operations minus two thousand one

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hundred crores which is the capex

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totally it is approximately twenty one

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thousand crores is their free cash flow

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the current market cap of infosys is

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seven lakh twenty four thousand crores

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so the fcf yield comes out to be

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approximately around two point 2.92

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which is fairly good it is not that bad

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if you look at some similar things you

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will find similar positive fcf wheel

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business for companies like asian paints

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and nestle why they're in the fmcg space

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consumer play but if you look at

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businesses like ntpc which is in the

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power segment the cash flows will look

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like this now look at the cash flows

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here right they're making cash flow from

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operating activities around again 24 000

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crores but their cash flow in investing

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activity is 30 000 crores it's much more

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right why because they have to invest a

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lot of money back to grow their company

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prudent that we should not base our

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decision on only this why because for

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this particular business we cannot look

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at fcf right for this particular type of

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business now it makes sense to evaluate

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business like infosys you know consumer

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place why because the fcs yield is high

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and everyone in the industry looks at

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fcf yield no fcf yield only whereas in

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these type of businesses people don't

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look at it they look at projects order

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books what is the revenue per order book

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all that has been seen in the power

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sector now it is very important to

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understand and i'll come to a conclusion

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and i'll tell you why something is very

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important to understand now when you

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look at fca field one core thing to look

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at is the long-term trend why i'm

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telling you look at long-term trend

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don't just look at one year and be like

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okay this is a great company look at how

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it has been performing in the past

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whether the cash flow is good whether

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the free cash flow is impressive whether

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the fca yield remains good and will it

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continue to be in the future that is

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something you have to definitely check

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now guys i hope you've got a super idea

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of what fcf is what fcf yield is why we

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look at fca yield and not earnings yield

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but again let me tell you something

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right all these are different ways of

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understanding a company right that means

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i'm not saying that this is the only way

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to analyze a company if this is not the

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only evaluation metric you should look

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at you should look at everything about

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the company there are multiple tools

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that you have to use for valuation this

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is one of the tools or else what will

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happen there's a very famous quote by

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abraham master maslow which basically

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says to a man with a hammer everything

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looks like a nail right so for a person

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who loves the stock market and you want

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to find something everything will look

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attractive so fcf yield is not the only

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tool for judging valuation and it may

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not work always also because sometimes a

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company with higher fcf yield maybe due

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to the company is not investing in the

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future also right maybe it's not doing

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kpecs and it's getting a lot of money or

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maybe there is companies that are doing

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good fcf but maybe they're over

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investing for their aggressive future

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right aggressive investing for the

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future so the company is still good but

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we'll see that from the fcf you'll be

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like no this is not good so don't base

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your decision on that so guys this was

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today's episode i hope you guys learned

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something uh i hope you guys could learn

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something more than what you what you

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started this video with so if you really

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liked what you saw today i would love

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for you guys to like this video share

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this video and subscribe to this channel

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because there's amazing content coming

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out every day right thank you guys this

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is me shashank udupa signing off

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investments in securities market are

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subject to market risks read all the

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