Free Cash Flow Yield Near Record Highs Through 5/16/22

The NC 2000’s trailing free cash flow (FCF) remains high, relative to recent quarters, because stock prices are declining more than FCF. I think the market is signaling expectations for further declines in FCF, and I expect prices will continue to fall until the end of FCF declines is in sight.

This report is an abridged version of All Cap Index & Sectors: Free Cash Flow Yield Near Record Highs 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 the 1Q22 10-Q in most cases. Price data is as of 5/16/22.

NC 2000 Trailing FCF Yield Rises Over the Last Year

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

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

Key Details on Select NC 2000 Sectors

With a 4.2% FCF Yield, investors are getting more FCF for their investment dollar in the Basic Materials sector than any other sector as of 5/16/22. On the flip side, the Industrials sector, at -0.9%, currently has the lowest trailing FCF yield of all NC 2000 sectors.

The Telecom Services, Energy, Utilities, Financials, Real Estate, Healthcare, Consumer Non-cyclicals, and Basic Materials sectors each saw an increase in trailing FCF yield from 6/30/21 to 5/16/22.

Below, I highlight the Energy sector’s trailing FCF yield.

The full version provides the same details for every sector as this report does for the Energy Sector.

Sample Sector Analysis: Energy

Figure 1 shows trailing FCF yield for the Energy sector rose from 0.7% as of 6/30/21 to 4.0% as of 5/16/22. The Energy sector FCF rose 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 to $3.1 trillion as of 5/16/22.

Figure 1: Energy Trailing FCF Yield: Dec 1998 – 5/16/22

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

Figure 2 compares the trends in FCF and enterprise value 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 “Aggregate” methodology, and it matches S&P Global’s (SPGI) methodology for these calculations.

Figure 2: Energy FCF & Enterprise Value: Dec 1998 – 5/16/22

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

The Aggregate methodology provides a straightforward look at the entire NC 2000/sector, regardless of market cap or index weighting, and matches how 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 pros and cons, which are detailed in the Appendix.

Figure 3 compares these three methods for calculating the Energy sector’s trailing FCF yields.

Figure 3: Energy Trailing FCF Yield Methodologies Compared: Dec 1998 – 5/16/22

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

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

Appendix: Analyzing Trailing FCF Yield with Different Weighting Methodologies

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

The Aggregate methodology provides a straightforward look at the entire NC 2000/sector, regardless of market cap or index weighting, and matches how 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 do not include market values, e.g. ROIC and its drivers, but I include them here, nonetheless, for comparison:

Market-weighted metrics – calculated by market-cap-weighting the trailing FCF yield for the individual companies relative to their sector or the overall NC 2000in each period. Details:

1. Company weight equals the company’s market cap divided by the market cap of the NC 2000/ its sector
2. I multiply each company’s trailing FCF yield by its weight
3. NC 2000/Sector trailing FCF yield equals the sum of the weighted trailing FCF yields for all the companies in NC 2000/sector

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

1. Company weight equals the company’s market cap divided by the market cap 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 weighted enterprise value for each company in the NC 2000/each sector to determine each sector’s weighted FCF and weighted enterprise value
4. NC 2000/Sector trailing FCF yield equals weighted NC 2000/sector FCF divided by weighted NC 2000/sector enterprise value

Each methodology has its pros and cons, as outlined below:

Aggregate method

Pros:

• A straightforward look at the entire NC 2000/sector, regardless of company size or weighting
• Matches how S&P Global calculates metrics for the S&P 500.

Cons:

• Vulnerable to impact of companies entering/exiting the group of companies, which could unduly affect aggregate values. Also susceptible to outliers in any one period.

Market-weighted metrics method

Pros:

• Accounts for a firm’s market cap relative to the NC 2000/sector and weights its metrics accordingly.

Cons:

• Vulnerable to outlier results from a single company disproportionately impacting the overall trailing FCF yield.

Market-weighted drivers method

Pros:

• Accounts for a firm’s market cap relative to the NC 2000/sector and weights its free cash flow and enterprise value accordingly.
• Mitigates the disproportionate impact of outlier results from one company on the overall results.

Cons:

• More volatile as it adds emphasis to large changes in FCF and enterprise value for heavily weighted companies.