Free cash flow is a critical financial metric that offers a more transparent view of a company’s profitability in the context of equity valuation. Historically, both free cash flow profitability and free cash flow yield have demonstrated strong predictive capabilities, surpassing their earnings counterparts in performance.
In this research paper, we delve deeper into the robustness of these two indicators by examining their effectiveness across various sectors, investment styles, and market regimes. Our analysis reveals that free cash flow profitability emerges as a more reliable and robust indicator, making it an excellent foundation for constructing a diversified core portfolio in comparison to free cash flow yield.
Consequently, we introduce the Free Cash Flow Quality Model (FCFQM) with free cash flow profitability as its cornerstone to assist investors in building resilient core equity holdings, designed for long-term investment horizons.