Free Cash Flow Conversion (FCF as % of GAAP Net Income)
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Free cash flow (FCF) equals the amount of cash free for distribution to all stakeholders and represents a truer measure of the cash profitability of a business. Not surprisingly, many of the world’s top investors focus on free cash flow when picking stocks.
Free cash flow conversion – formula in Figure 1 – measures a company’s ability to convert GAAP profits into free cash flow.
Figure 1: How to Calculate FCF Conversion
FCF / GAAP Net Income
Where
FCF = NOPAT – Change in Invested Capital
Sources: New Constructs, LLC and company filings
We provide FCF as a % of GAAP net income in each of our Company Models, which also provide all cash/no cash calculations of FCF. The FCF conversion ratio provides insights into how effectively a company converts net income into free cash flow. Higher FCF conversion ratios imply a company is turning more of its GAAP profits into cash, and a lower ratio represents the opposite.
Figure 2 shows the S&P 500 companies with the highest and lowest FCF conversion ratios as of August 20, 2024.
This paper compares our analysis on a mega cap company to other major providers.
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