If you want better stock returns with less risk, this article shows you how to find companies that generate real, hard cash — and use that to your advantage. You will learn how to use the free cash flow yield ratio to spot undervalued, high-quality companies quickly.
This ratio beats most others, works globally, and helps you avoid common investor mistakes. You will also see how combining it with momentum can double your returns. By the end, you will have a simple, proven system to invest smarter — and stay calm during market dips. This strategy is practical and easy to apply today.
Estimated Reading Time: 6 minutes
How to Find High Free Cash Flow Companies
If you are managing your own investments, one ratio can help you find quality, undervalued ideas — High free cash flow companies.
Free cash flow is the real money left over after a company pays all its operating expenses and capital expenditures. It shows you what is going into the bank. And when you compare cash flow to the total value of the business — free cash flow yield — you can quickly find quality companies selling at a good price.
In this guide, you will learn what free cash flow yield is, how to use it, and why it has worked so well across the world. You will also learn how to combine it with other indicators to get even better results.
What Is Free Cash Flow Yield?
Free cash flow yield is a simple ratio that helps you value a company based on its real cash generation.
Here is how you calculate it: Free Cash Flow / Enterprise Value
Free cash flow is the cash a company has left after subtracting capital expenditure from operating cash flow. You get this number directly from the company’s cash flow statement. Then you divide it by enterprise value — which includes the company’s market capitalization, debt, minority interest, and subtracts excess cash.
Why use cash instead of earnings or profit?
Cash is Hard to Fake
Because free cash is hard to fake. Cash at the start of the year, plus or minus what comes in or out, equals the cash at the end. That is why free cash flow yield is known as a “clean” valuation ratio.
Why Free Cash Flow Yield Is a Powerful Strategy
A high free cash flow yield tells you two things:
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The company is generating a lot of actual cash.
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The business may be undervalued compared to its cash generation power.
Free Cash Flow Yield Backtest #1
When you compare this across companies, it becomes clear which ones are cash generating and which are not. Backtests have confirmed this.
In a massive 40-year study by Alpha Architect, five valuation ratios were tested:
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Earnings to Market Value
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EBITDA to Enterprise Value
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Free Cash Flow to Enterprise Value
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Gross Profits to EV
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Book to Market (inverse of Price to Book)
Free cash flow yield came in second place, with an annual return of 16.6%, only 1.1% behind the best performer—EBITDA to EV.
That is a very strong showing. It beat Price to Earnings, Gross Profit to EV, and Book to Market.
This is what they found:
Source: Analyzing Valuation Measures: A Performance Horse-Race over the past 40 Years.
The Equal Weight Value part of the table shows the equal-weighted returns of the most undervalued (cheap) 20% of companies based on each ratio.
The Equal Weight Growth part of the table shows the equal-weighted returns of the most overvalued (expensive) 20% of companies based on each ratio.
The Spread (Value-Growth) part of the table shows the difference between the Equal Weight Value and Equal Weight Growth returns of the two above tables.
What they found
As you can see (look at the dark green areas of the table) they did not find that using normalized ratios (2yrs to 8yrs) can add to your returns. Only normalized book to market (inverse of price to book) would have given you slightly higher returns compared to the one-year ratio.
The best valuation ratio they found was trailing 12 month EBITDA to EV with an average return of 17.7% over the 40 year test period.
What about free cash flow yield? Second best ratio
As you can see free cash flow yield was the second-best ratio they tested, at 16.6%.
Still a very respectable return.
Click here to start finding your own high FCF Yield ideas NOW!
Free Cash Flow Yield Backtest #1
How Free Cash Flow Yield Performed in Europe
The same strategy was tested in Europe, against 168 investment strategies over 12 years.
The researchers compared:
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12-month free cash flow yield
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5-year average free cash flow yield (normalized)
This is what we found:
Free Cash Flow Yield Trailing 12 months returns (Source: Quantitative Value Investing in Europe: What Works for Achieving Alpha)
Free Cash Flow Yield – 5 year average returns (Source: Quantitative Value Investing in Europe: What Works for Achieving Alpha)
Q1 (Quintile 1) represents the cheapest 20% of companies and Q5 (quintile 5) the most expensive.
They found that 12-month FCF yield produced the best results. The difference between the cheapest 20% and the most expensive 20% of stocks (based on FCF yield) was 257.8% on average over the period.
Even though the 5-year average had better returns for some company sizes, it was less consistent overall.
And just to be clear, these returns were much better than the market’s return of just 2.25% per year, including dividends.
Why This Strategy Works
There are a few reasons why high free cash flow yield consistently works:
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It avoids overhyped stocks. You are buying companies based on real results, not hope.
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It highlights cash efficiency. Companies with high operating cash flow and low capital needs shine here.
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It is global. It has worked in the USA, Europe, and Asia across many industries.
Another reason is that many investors focus on earnings or book value. But these can be misleading. Earnings can include non-cash items. Book value ignores things like brand, technology, or customer loyalty.
Free cash flow includes it all—because it shows what is really left over.
Click here to start finding your own high FCF Yield ideas NOW!
How to Screen for High Free Cash Flow Companies
To use this strategy, you do not need to analyse every company by hand. You can use a stock screener that you can set up to for example find:
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Top 20% of stocks by free cash flow yield
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Minimum market value of $100 million
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Minimum daily trading volume of $100,000
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Recent financial statements (within the last 6 months)
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Exclude financials and utilities
These filters help you avoid companies that are illiquid or hard to analyse.
You can use predefined screens in tools like the Quant Investing Screener. There is even a ready-made “Free Cash Flow Momentum Screen” you can load in one click. Just pick your regions, adjust the filters, and apply the screen.
And once you have it set up, you can save your screen, so you do not have to start from scratch each time.
Want Better Returns? Combine With Momentum
You can increase your results dramatically by combining free cash flow yield with momentum.
In the same 12-year Europe study, combining high FCF yield with 12-month price momentum gave investors a return of 755%, compared to just 248.7% for free cash flow yield alone.
That is a 506% improvement. More than double.
The following table shows you the returns you could have achieved if you can combined high 12-month free cash flow yield companies with other ratios and indicators in the left column.
Source: Quantitative Value Investing in Europe: What works for achieving alpha
Look at column Q1
Look at the returns in column Q1, it shows the returns generated by first selecting the 20% best free cash flow yield companies combined with the ratios in the column called Factor 2.
How is momentum measured?
With the Price Index 12 Months: Current share price ÷ share price 12 months ago. Companies in the top 20% of momentum often continue to perform well.
So, if you want stronger gains, look for stocks that have:
✅ High free cash flow yield
✅ High 12-month momentum
This combo finds high FCF Yield momentum stocks — companies that are undervalued and already moving in the right direction.
How to Get Started
Here is a quick setup you can use:
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Log in to your stock screener
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Load the “Free Cash Flow Momentum” predefined screen
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Pick your countries or regions
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Set minimum volume: $100 = $100,000
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Set minimum market value
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Apply screen and view results
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Save your setup for next time
Once you have a list, take a closer look at debt to equity and the Piotroski F-Score. Make sure the business is solid—not just cheap.
And remember to diversify. Hold at least 20–30 companies to manage risk.
Mistakes to Avoid
No strategy is perfect. Even with high free cash flow yield, you need to be careful.
Watch out for:
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Unusual outliers with very high FCF yields—check for one-time events
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Declining sales or large increases in debt
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Very small companies with little trading volume or liquidity
Also, remember that working capital increases, or rising expenses, can reduce future free cash flow.
If you see red flags, move on.
When to Rebalance Your Portfolio
The backtests above used annual rebalancing. That means every 12 months, you:
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Sell companies that no longer meet your criteria
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Replace them with new top 20% free cash flow yield + momentum stocks
This keeps your portfolio fresh and ensures you stay focused on high cash flow, reasonable price stocks.
You do not need to rebalance every month. Once per year is enough.
Click here to start finding your own high FCF Yield ideas NOW!
Final Thoughts
If you are looking for a simple, data-backed way to invest with confidence, high free cash flow yield is one of the best ratios you can use. It is based on actual cash, not forecasts. It works in the USA and Europe. It can be used with momentum for even better returns. And it is easy to implement using a screener.
Plus, it helps you stay focused during tough times. When you know you are investing in businesses that are profitable and generating cash, it is easier to stay calm when the market is not.
You do not need perfect timing. You just need a system—and the discipline to follow it.
FREQUENTLY ASKED QUESTIONS
1. Why should I care more about free cash flow than earnings?
Because cash is real. Earnings can be full of accounting tricks or non-cash items. But free cash flow tells you how much actual money is left after running the business. It is the cash a company could use to pay dividends, reduce debt, or buy back shares. You want to invest in businesses that generate cash, not just ones that look good on paper.
2. How do I know if a free cash flow yield is high enough?
Look for companies in the top 20% of the market based on free cash flow yield. That usually means a free cash flow yield above 8%–10%, but it depends on the market and sector. A screener can rank them for you. The higher the yield, the more undervalued the company might be—if its cash flow is solid.
3. What if a stock has a very high FCF yield—like 30%? Is that a great deal?
Not always. A very high number can be a red flag. It could mean a one-time gain, falling sales, or rising debt. Always check if the cash flow is consistent and if the business is stable. Look at sales trends and debt levels. If something looks too good to be true, it often is.
4. Can I just buy high FCF yield stocks and forget about the rest?
It is a great starting point—but no, do not stop there. Free cash flow yield shows value, but momentum shows direction. The best returns came from combining both. Buy companies that have high cash flow and rising prices over the last 12 months. It means the market is already starting to notice the value.
5. What kind of companies should I avoid, even if their FCF yield is high?
Avoid:
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Financials and utilities (their cash flows are harder to compare).
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Tiny stocks with very low trading volume (hard to sell quickly).
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Companies with weak recent results or red flags in their balance sheet. Use filters like minimum market cap and volume to avoid trouble.
6. How often should I rebalance if I follow this strategy?
Once a year is enough. That is what the backtests used. You sell the stocks that no longer meet your criteria and replace them with new top 20% free cash flow + momentum stocks. It keeps your portfolio fresh, but without needing monthly trades.
7. Is this strategy too complex for a self-managed investor like me?
Not at all. In fact, it is perfect. You use a screener to find the right stocks, save your setup, and rebalance once a year. No guesswork, no emotional decisions. It gives you confidence because the numbers back it up. Many investors using this approach have beaten the market—with less stress and more clarity.
Click here to start finding your own high FCF Yield ideas NOW!
