Enterprise Value to Free Cash Flow (EV/FCF)

EV/FCF combines two of the most robust financial concepts: enterprise value (full acquisition cost) and free cash flow (cash available after reinvestment). It is arguably the most theoretically sound valuation multiple.

Unlike EV/EBITDA, EV/FCF accounts for actual capital expenditures. A company with high EBITDA but enormous capex needs will appear cheap on EV/EBITDA but expensive on EV/FCF, revealing the true cost of maintaining the business.

EV/FCF is the multiple most closely aligned with a discounted cash flow model. A low EV/FCF implies a high FCF yield to the enterprise, which, if sustainable, translates directly to shareholder returns.

Lower EV/FCF indicates a higher yield of free cash flow per dollar of enterprise value. An EV/FCF below 15 is generally attractive; below 10 enters deep-value territory.

EV/FCF can fluctuate more than EV/EBITDA because FCF is lumpier than EBITDA. Capital expenditures can spike in investment years and decline in harvest years, causing EV/FCF to oscillate. Use a 2-3 year average FCF to smooth this out.

The inverse of EV/FCF is FCF yield to enterprise, which can be compared directly against the weighted average cost of capital. If FCF yield exceeds WACC, the stock may be undervalued on a DCF basis.

Asset-light businesses (software, consulting, media) often show EV/FCF close to EV/EBITDA because capex is minimal. These sectors commonly trade at 15-30x EV/FCF.

Capital-heavy industries (energy, mining, telecoms) show large gaps between EV/EBITDA and EV/FCF. An oil company at 5x EV/EBITDA might be 20x EV/FCF during a heavy drilling cycle.

For sectors with lumpy capex, compare EV/FCF over a full investment cycle rather than a single year.