By many metrics, the stock market is among the most expensive in history.
But Goldman Sachs finds that, from one perspective, it’s actually quite average.
The gauge in question is free cash flow (FCF) yield, which measures a company’s FCF relative to its market value. Generally, the lower it is, the more attractive investment opportunities are. And right now, it’s sitting comfortably in the 56th percentile compared to history, according to Goldman data.
But it’s not that simple. This discrepancy only exists because capital expenditures (capex) as a share of cash flow from operations (CFO) are historically low, says Goldman.
“Every dollar of CFO not spent on capex is accretive to FCF,” Goldman clarifies. “Firms with high FCF yield often appear attractively valued simply because they have slashed capex.”
What investors should do is adjust FCF yield to incorporate how much a company is investing in both growth capex and research and development, says David Kostin, the firm’s chief US equity strategist. Then, once they have a firm handle on adjusted FCF yield, they can make informed stock picks.
This is particularly useful for value investors, or those seeking bargins in the market. It helps them avoid so-called value traps — the term used for companies that are cheap simply because they’re bad.
In the end, adjusted FCF yield is intended to identify good companies whose stocks also meet the traditional definition of value.
Luckily for value investors, Goldman maintains a basket of high adjusted FCF yield companies. The firm’s top 12 picks are as follow: