The best yield-based valuation measure is a relatively little-known metric called Cash Return ratio. In many ways it’s actually a more useful tool than the P/E.
Cash Return ratio
The best yield-based valuation measure is a relatively little-know metric called Cash Return ratio. In many ways it’s actually a more useful tool than the P/E. To calculate cash return, divide free cash flow by enterprise value.
Cash Return Formula
Cash Return = Free Cash Flow/Enterprise Value = Free Cash Flow/(Market Cap + debt – Cash)
The goal of Cash Return is to measure how efficiently the business is using its capital –both equity and debt-to generate free cash flow. Essentially cash return tells you how much free cash flow a company generates as a percentage of how much it would cost to buy the whole shebang, including the debt burden.
Cash Return is a great first step to finding cash cows trading at reasonable prices.
You may also like to learn more on yield-based and other valuation measures, as below.