Free Cash Flow Yield Stagnant In 2Q23

The S&P 500’s free cash flow (FCF) yield changed very little in 2Q23 and remains well above its long-term average on a trailing basis and is at its highest levels since 12/31/18.

At the sector level, there are mixed signals. Five sectors saw FCF yields go up while five saw them decline – and to varying degrees.

Over the last several quarters, I’m seeing a clear trend that the S&P 500’s FCF yield looks to be topping out, which reflects, in my opinion, how outside of the few stocks driving the major indices higher, the rest of the market is struggling.

This report is an abridged version of S&P 500 & Sectors: Free Cash Flow Yield Stagnant in 2Q23, one of my quarterly series on fundamental market and sector trends. I calculate these metrics based on S&P Global’s (SPGI) methodology, which sums the individual S&P 500 constituent values for free cash flow and enterprise value before using them to calculate the metrics. I call this the “Aggregate” methodology. This report is based on the latest audited financial data available, which is the 2Q23 10-Q in most cases. Price data is as of 8/15/23.

Trailing FCF Yield Remains Largely the Same in 2Q23

Only five S&P 500 sectors saw an increase in trailing FCF yield from 6/30/23 to 8/15/23.

Key Details on Select S&P 500 Sectors

With a 6.8% FCF Yield, investors are getting the highest FCF for their investment dollar in the Energy sector as of 8/15/23. On the flip side, the Utilities sector, at -2.8%, currently has the lowest trailing FCF yield of all S&P 500 sectors.

The Consumer Cyclicals, Real Estate, Industrials, Utilities, and Technology sectors each saw an increase in trailing FCF yield from 6/30/23 to 8/15/23.

Below, I highlight the Consumer Non-cyclicals sector, which saw no change in FCF yield through 8/15/23.

Sample Sector Analysis: Consumer Non-cyclicals

Figure 1 shows the trailing FCF yield for the Consumer Non-cyclicals sector remained flat at 2.8% as of 8/15/23. The Consumer Non-cyclicals sector’s FCF fell from $89.2 billion in 1Q23 to $88.4 billion in 2Q23, while enterprise value fell from $3.14 trillion as of 6/30/23 to $3.11 trillion as of 8/15/23.

Figure 1: Consumer Non-cyclicals Trailing FCF Yield: Dec 2004 – 8/15/23

The August 15, 2023 measurement period uses price data as of that date and incorporates the financial data from 2Q23 10-Qs, as this is the earliest date for which all the 2Q23 10-Qs for the S&P 500 constituents were available.

Figure 2 compares the trends in FCF and enterprise value for the Consumer Non-cyclicals sector since 2004. I arrive at these numbers by adding up the individual S&P 500/sector constituents’ free cash flow and enterprise value. I call this approach the “Aggregate” methodology, and it matches S&P Global’s (SPGI) methodology for these calculations.

Figure 2: Consumer Non-Cyclicals FCF & Enterprise Value: Dec 2004 – 8/15/23

The August 15, 2023 measurement period uses price data as of that date and incorporates the financial data from 2Q23 10-Qs, as this is the earliest date for which all the 2Q23 10-Qs for the S&P 500 constituents were available.

The Aggregate methodology provides a straightforward look at the entire S&P 500/sector, regardless of market cap or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for free cash flow with two other market-weighted methodologies: market-weighted metrics and market-weighted drivers. Each method has its pros and cons, which are detailed in the Appendix.

Figure 3 compares these three methods for calculating the Consumer Non-cyclicals sector’s trailing FCF yields.

Figure 3: Consumer Non-cyclicals Trailing FCF Yield Methodologies Compared: Dec 2004 – 8/15/23

The August 15, 2023 measurement period uses price data as of that date and incorporates the financial data from 2Q23 10-Qs, as this is the earliest date for which all the 2Q23 10-Qs for the S&P 500 constituents were available.

Disclosure: David Trainer, Kyle Guske II, Italo Mendonça, and Hakan Salt receive no compensation to write about any specific stock, style, or theme.

Appendix: Analyzing Trailing FCF Yield with Different Weighting Methodologies

I derive the metrics above by summing the individual S&P 500/sector constituent values for free cash flow and enterprise value to calculate trailing FCF yield. I call this approach the “Aggregate” methodology.

The Aggregate methodology provides a straightforward look at the entire S&P 500/sector, regardless of market cap or index weighting, and matches how S&P Global (SPGI) calculates metrics for the S&P 500.

For additional perspective, I compare the Aggregate method for free cash flow with two other market-weighted methodologies. These market-weighted methodologies add more value for ratios that do not include market values, e.g. ROIC and its drivers, but I include them here, nonetheless, for comparison:

Market-weighted metrics – calculated by market-cap-weighting the trailing FCF yield for the individual companies relative to their sector or the overall S&P 500 in each period. Details:

1. Company weight equals the company’s market cap divided by the market cap of the S&P 500/ its sector
2. I multiply each company’s trailing FCF yield by its weight
3. S&P 500/Sector trailing FCF yield equals the sum of the weighted trailing FCF yields for all the companies in the S&P 500/sector

Market-weighted drivers – calculated by market-cap-weighting the FCF and enterprise value for the individual companies in each sector in each period. Details:

1. Company weight equals the company’s market cap divided by the market cap of the S&P 500/ its sector
2. I multiply each company’s free cash flow and enterprise value by its weight
3. I sum the weighted FCF and weighted enterprise value for each company in the S&P 500/each sector to determine each sector’s weighted FCF and weighted enterprise value
4. S&P 500/Sector trailing FCF yield equals weighted S&P 500/sector FCF divided by weighted S&P 500/sector enterprise value

Each methodology has its pros and cons, as outlined below:

Aggregate method

Pros:

• A straightforward look at the entire S&P 500/sector, regardless of company size or weighting.
• Matches how S&P Global calculates metrics for the S&P 500.

Cons:

• Vulnerable to impact of companies entering/exiting the group of companies, which could unduly affect aggregate values. Also susceptible to outliers in any one period.

Market-weighted metrics method

Pros:

• Accounts for a firm’s market cap relative to the S&P 500/sector and weights its metrics accordingly.

Cons:

• Vulnerable to outlier results disproportionately impacting the overall trailing FCF yield.

Market-weighted drivers method

Pros:

• Accounts for a firm’s market cap relative to the S&P 500/sector and weights its free cash flow and enterprise value accordingly.
• Mitigates the disproportionate impact of outlier results from one company on the overall results.

Cons:

• More volatile as it adds emphasis to large changes in FCF and enterprise value for heavily weighted companies.