Companies With High Free Cash Flow Margins and High Free Cash Flow Yields Massively Outperform the Market Over Time
In our prior dispatch, we learned that return on invested capital (ROIC) is the most important financial metric because:
Return on invested capital is calculated as net operating profit after tax (NOPAT) divided by average invested capital, so it has a robust profitability metric in the numerator and a balance sheet measure in the denominator. In this way, it is the linchpin that connects a company's profitability (income statement), balance sheet, and free cash flow (FCF).
And strong and growing free cash flow (particularly FCF per share) is ultimately what we are after as investors. As we stated (and repeated) in the linked article and are restating again now, businesses with higher ROIC generate more FCF per dollar of earnings, and growth of free cash flow is what drives growth of intrinsic value! In fact, the definition of intrinsic value (also referred to as fair or fundamental value) is the present value of future free cash flows. Fair value can also be thought of as the price you can pay for a stock and roughly earn your required rate of return (or hurdle rate in your discounted cash flow model).
Source Fool.com
