Free cash flow (FCF) is the cash left after operating expenses and capital expenditures. It's what management can actually return to shareholders, reinvest, or use to pay down debt. Warren Buffett has called it "owner earnings" for good reason.
Definition and formula
FCF = Cash from operations − Capital expenditures
Both numbers come from the cash flow statement. A company with $10 billion in operating cash flow and $3 billion in capex generates $7 billion in free cash flow.
Why FCF beats earnings
- Cash flow ignores non-cash accounting choices like depreciation schedules.
- It captures working-capital changes — earnings can look great while cash gets tied up in inventory.
- It reflects the real cost of maintaining the business (capex), which earnings understate for capital-intensive companies.
Free cash flow yield
FCF yield = Free cash flow ÷ Market cap
FCF yield is the cash return you'd get if the entire business paid out all its free cash flow. It's directly comparable to bond yields and often more honest than earnings yield.
Quality of cash flow
- Watch stock-based compensation — it's a real cost that operating cash flow ignores.
- Distinguish maintenance capex from growth capex when possible.
- Beware of consistent gaps between reported net income and FCF over multiple years.
How to use it
Track FCF year over year and per share (divide by share count). Rising FCF per share over a decade is one of the clearest signals of a compounding business.
Frequently asked questions
Why is free cash flow considered more reliable than earnings?
Cash flow is harder to manipulate. Earnings involve accounting judgment — depreciation schedules, revenue recognition, tax choices. Cash either arrived in the bank account or it didn't.
What's a good FCF yield?
There's no fixed answer, but 5% is often considered decent for the broad market. Anything above 8–10% on a stable business is worth investigating; anything below 2% requires strong growth to justify.
Can a fast-growing company have negative free cash flow?
Yes — many great compounders had negative FCF for years while investing heavily. The right question is whether that investment is producing durable returns and whether cash flow will turn positive on a reasonable timeline.
Put this into practice
Open a real ticker, ask Auri your own questions, and track what you learn — all in one calm workspace.