Imagine you are an investor and you are looking to deploy your capital to buy a business. There are a variety of financial and non-financial measures you could use.
One of the common measures is calculating the Free Cash Flow to Enterprise Value ratio. Let’s break down what they both mean.
Free Cash Flow is how much cash you have left after running the business for a profit and subtracting your costs to maintain the business. The first is commonly called Cash from Operations and the second is called a Capital Expenditures. Usually the numbers are added together and calculated for the trailing twelve months.
Enterprise Value is the value of the business equity (for our purposes market cap is a good approximation) plus the value of all business debt minus all cash the business currently owns. It gives a holistic view on the minimum necessary to acquire the business in full.
The great thing is that for stock investments much of the work on getting the data is readily available.
Step 1: go to Finance.yahoo.com
Step 2: enter a stock symbol in the Quote Lookup search bar on the far left. In this case we will look up Apple, which has symbol AAPL.
Step 3: this brings you to the summary page. Again going to the far left you will see Key Statistics under the Company subheading. Click on that.
Step 4: under Valuation Measures the Enterprise Value is listed second from the top. For Apple, that is 663.51 Billion dollars as of August 28th, 2015. Your value will be different depending on the day you look.
Step 5: scroll towards the bottom of the Key Statistics page. You will see something in small print called View Financials. Click on Cash Flow. We will use the Cash Flow statement to calculate our Free Cash Flow yield.
Step 6: all these numbers may seem intimidating. We are only concerned with two rows, Total Cash Flow From Operating Activities and Capital Expenditures. Make sure the Quarterly Data view is selected.
As of August 28th, 2015 the quarters ending Jun 27, 2015, Mar 28 2015, Dec 27, 2014, and Sep 27, 2014 are available. Adding together the Cash Flow from Operations gives me about 81 Billion dollars.
I similarly add together all the numbers for Capital Expenditures. That gives me 11.5 Billion dollars.
If I owned 100% of Apple how much cash is available to me the investor? We take our 81 Billion in operating cash flow and subtract our 11.5 Billion in Capital Expenditures. That gives me about 69.5 Billion in Free Cash Flow. Wow. That’s a big number. How do I know if that’s any good? Wonder if I invested 6 Trillion dollars? That doesn’t look so good. And if I had invested 100 Billion I would have a return of 70%!
What we do is we take our Free Cash Flow of 69.5 Billion and divide by the Enterprise Value of 663.51 Billion we found earlier. That gives me a yield of 10.5%. That’s a good return. Should you blindly invest? No. What is the minimum return you need to meet your goals? Let’s assume I am investing for retirement and I need 14% a year from my investments to reach my retirement goal. By that measure Apple is not a good investment for me at this time.
If I were to modify Enterprise Value to subtract out all Cash and liquid Investments (Apple had a total of 203 Billion as of last quarter) I calculate a modified Enterprise Value of 476.0 Billion. If I recalculate my ratio I now get 14.6%, which is above my minimum 14% target. Barring all other significant factors which we excluded this might be a good time to invest.
What are some of those other significant factors? I would ask the following. How long can these free cash flows be sustained? Will the business, economic, and political climate change enough to change my investments? How strong is the competition? What happens if the Enterprise Value deviates much higher or lower? Some things to think about.
I plan to try out this strategy with my investments. My minimal return per year going forward is 14% on all invested assets. And if I do that consistently I can retire when I want with the amount of money I want. There are many ways to get that destination. Your method and my method might differ. What matters is only that we reach our respective goals.
Good luck!
Vijay @ smilingdad
smilingdad 
I seem to do very well with index funds. On a whole, I made about 22% in 2014 and about 34% in 2013. Yahoo Finance is a good resource for research, but I also think TD Ameritrade has some useful tools also.
LikeLiked by 1 person
Those are excellent returns. You would have beaten 90% of active and hedge fund managers with that record. May I ask which index fund you use? I am in the process of looking for a place to invest the conservative part of our portfolio. Yes Yahoo Finance is good for basic research. I have never used TD Ameritrade. I have heard good things. I am currently in the process of switching accounts to Interactive Brokers. What research do you like with TD Ameritrade? Thanks for your comment!
LikeLiked by 1 person
The returns are based on a compilation of index funds both domestic and foreign, bonds (although I believe they will drop when interest rates rise), treasuries, and a 100% match from my employer. I also invest in equities on my own so I can cherry pick. For example, I purchased Apple when it dropped to $40 a share, Citibank when it dropped to $4, etc. This strategy allows me to take advantage of the employer plan and also when Wall St has a sale! I also keep my investments well diversified. Vanguard and Black Rock are the leaders for index funds, but I would have to take a look to give you specifics. TD Ameritrade is great and I am very happy with them. They allow you to convert information into various charts and spreadsheets to keep track.
LikeLike