Below 3% - expensive
Only justified by high, durable growth: the market is pricing years of compounding. Common for premium software compounders.
Benchmark
What is a good FCF yield?
A good free cash flow yield is generally 5% or higher - comfortably above the roughly 4% ten-year Treasury, which gives you a positive equity risk premium. A 5-8% yield is the sweet spot for a stable, cash-generative business; below 3% only makes sense if cash flow is growing fast; above 8% is either a genuine bargain or a signal that the market expects cash flows to fall.
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Short answer
If the FCF yield clears the ten-year Treasury with room to spare and free cash flow is growing, the price is reasonable. A 6-8% yield on a durable, growing business is the value investor's sweet spot - a bond-like coupon with equity upside.
What counts as a good FCF yield, by range
3-5% - fair
Roughly a market-average valuation. Acceptable for quality businesses with steady, reliable growth.
5-8% - attractive
A clear premium over Treasuries. The classic value zone for stable, cash-generative companies.
Above 8% - cheap or risky
Either a real bargain or the market is signaling falling cash flows. Always check which one it is before buying.
A worked example
Take a company producing 700 million dollars of free cash flow with a 10 billion dollar market cap. FCF yield is 700 divided by 10,000, or 7 percent. Against a 4 percent ten-year Treasury, that is a 3-percentage-point equity risk premium.
If that free cash flow grows around 4 percent a year, the total-return profile rivals high-quality corporate bonds - but with equity upside and far less interest-rate sensitivity. That combination of a 5-8 percent starting yield plus modest growth is what value investors hunt for.
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Related
- What is FCF yield? - the full definition, the formula, and how it compares to P/E and dividend yield.
- What is free cash flow? - operating cash flow minus capex - the number the yield is built on.
- Top Buffett-fit stocks today - the live ranking of US-listed stocks with the most attractive FCF yields against Buffett's rubric.
See FCF yield on a real verdict
Every Buffett-Fit verdict on invest-like reports current FCF yield against the ten-year Treasury benchmark, so you can judge "good" in context.
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