NEW YORK ( Stockpickr) -- Most investment professionals will tell you that a companyâ¿¿s profits are a work of fiction.
A company can calculate various expenses in countless ways to arrive at whatever figure looks best. Many focus on free cash flow, the number that you get after capital spending has been deducted from operating profit. It tends to be a more accurate number, and gives a real sense of whether a company is really adding cash to its balance sheet.
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Free cash flow can also serve as a handy way to value a stock. You simply divide free cash flow by a companyâ¿¿s enterprise value (market value plus debt minus cash). For example, if a company has $700 million in annual free cash flow and an enterprise value of $10 billion, it has a free cash flow yield of 7%.
As a general rule of thumb, any stock with a free cash flow yield above 5% is a good value. If that figure approaches 8% or 10%, itâ¿¿s a stunning bargain.
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five companies with very impressive free cash flow yields
. (The average free cash flow of the past five years has been divided by the current enterprise value.)
(CSCO - Get Report)
has generated an impressive $9.5 billion in average annual free cash flow over the past five years. In the context of Ciscoâ¿¿s $91 billion market value, that might seem impressive. Yet when you consider that Cisco has $36 billion in net cash, the enterprise value drops to just $55 billion. That translates into a free cash flow yield of 17%, which is truly eye-popping.
So what to do with the free cash flow? Well, share buybacks are one beneficiary: Ciscoâ¿¿s share count has been shrinking for nine straight years and is now 20% smaller than it was in fiscal 2004. Cisco has also been paying more attention to its dividend, which now yields 3.2%. That tremendous free cash flow tells you that Cisco could double or even triple its dividend without weakening its balance sheet.
Cisco was also highlighted in â¿¿
5 Cash-Rich Companies to Buy