PE tells you what you pay per rupee of accounting profit. Free cash flow yield tells you what you get per rupee invested, in actual cash, after the business has paid for everything it needs to keep running. When the two disagree, the second is usually closer to the truth.
- free cash flow
- operating cash flow minus capital expenditure
- market capitalisation
- share price × shares outstanding
- result
- the cash return on buying the whole company at today’s price
Example: ₹450 crore of free cash flow against a ₹6,000 crore market cap is a 7.5% FCF yield — comparable to what a bond would pay, from a business that may also grow.
A flat rents for ₹30,000 a month, so ₹3.6 lakh a year. But painting, repairs and society charges take ₹80,000. What actually reaches you is ₹2.8 lakh — and against a ₹60 lakh purchase that is a 4.7% yield, not 6%.
FCF yield does exactly this for a business: takes the cash it generates, subtracts what it must spend to keep going, and compares the rest with what you paid.
Why it beats earnings yield
| Earnings yield (1/PE) | FCF yield | |
|---|---|---|
| Based on | Accounting profit | Cash after capex |
| Affected by depreciation policy | Yes | No |
| Affected by revenue recognition | Yes | Much less |
| Counts working capital drain | No | Yes |
| Counts capex needed to survive | No | Yes |
| Easy to manipulate | Considerably | Difficult |
The maintenance capex problem
Plain FCF subtracts all capex, which understates a company that is spending heavily to grow. What you ideally want is maintenance capex — the spending required just to stand still — with growth capex treated separately as an investment decision.
- 1Start with depreciation
A rough proxy for the capital consumed each year. Imperfect, since it reflects historical cost rather than replacement cost.
- 2Compare against capex in flat years
Find a year when capacity did not expand. What was spent then is close to genuine maintenance.
- 3Check the segment and capex disclosure
Many companies separate expansion projects from routine spending in their presentations.
- 4Treat growth capex as optional
It should be judged on the return it earns — which is the incremental-return question, not a cost of staying alive.
A DCF is FCF yield extended over many years. Both stand on the same input, which is why estimating free cash flow well matters more than the model around it.
- Stable demand, cash flow steady for years
- Low maintenance capex relative to profit
- Cash used for dividends, buybacks or good reinvestment
- Modest but real growth
- Peak of a commodity cycle
- Structurally declining end market
- Cash flow flattered by deferred maintenance
- Management hoarding cash with no plan
A company has a PE of 14 (earnings yield about 7%) but an FCF yield of 1%. What is the most likely explanation?
Flat ka kiraya saal ka ₹3.6 lakh hai — sunke 6% lagta hai. Par paint, marammat aur maintenance ke ₹80,000 nikal do toh haath mein ₹2.8 lakh, matlab 4.7%. FCF yield yahi karti hai — jo cash sach mein bacha, usko keemat se baant do. PE isse chhupa deti hai.
- FCF yield is cash after capex divided by market capitalisation — what a buyer of the whole company would receive.
- It is far harder to manipulate than accounting earnings.
- A wide gap between earnings yield and FCF yield is itself the warning.
- Separate maintenance capex from growth capex before judging.
- Very high FCF yields often signal a cyclical peak or structural decline, not a bargain.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- free cash flow yield meaning
- Free cash flow yield is a company’s free cash flow divided by its market capitalisation, expressed as a percentage — the cash return you would earn on buying the whole business at today’s price. Free cash flow itself is operating cash flow minus capital expenditure. So ₹450 crore of free cash flow against a ₹6,000 crore market capitalisation is a 7.5% FCF yield.
- operating cash flow minus capital expenditure is known as
- Free cash flow. It is what the business generates after paying for the assets it needs, so it is the cash actually available to the people who funded it. Dividing that figure by market capitalisation gives the free cash flow yield, and the same figure projected over many years is what a DCF model is built on.
- difference between earnings yield and free cash flow yield
- Earnings yield is the inverse of the PE ratio and rests on accounting profit; FCF yield rests on cash left after working capital and capital expenditure. Depreciation policy and revenue recognition move earnings but barely touch free cash flow, which makes the cash number considerably harder to manipulate. The gap between the two is itself the signal — a 6% earnings yield alongside a 1% FCF yield means reported profit is being consumed before it ever reaches an owner.
- what is maintenance capex
- Maintenance capex is the capital spending a company needs just to keep its existing capacity running, as distinct from growth capex that adds new capacity. It matters because plain free cash flow subtracts all capex and therefore understates a business spending heavily to expand. Depreciation is a rough proxy for it, and capex in a year when capacity did not expand is usually closer to the real figure.
- why can a high free cash flow yield be a warning sign
- Because an unusually high yield often means the market expects the cash to stop. Cyclical businesses print their largest FCF yields at the top of a cycle, precisely when earnings are about to fall, and companies in structural decline generate cash while shrinking — the cash goes when the business does. A yield can also be flattered temporarily by maintenance spending that has simply been deferred.