Free Cash Flow measures how much cash a company generates. It is the true milestone of corporate value creation because it shows how much cash a company is generating from year to year.
Market Cap to Free Cash Flow Indicates, How much investors are willing to pay to buy the business for every Rs 1 of Free cash flow. The inverse of this ratio is popularly known as FCF Yield
Market Cap to Free Cash Flow = Market Capitalization / Free Cash Flow
Company ABC makes FCF of Rs 1000 Cr and the Market Cap is Rs 50000. The Market Cap to FCF ratio is 50. This indicates that investors are willing to pay Rs 50 to buy this company for every Rs 1 of FCF generated by the company.
How to Use practically
Investors have to rank the company based on Market cap to FCF Ratio, Company from lower to the higher order. The chances of finding multi-bagger stocks are high if you chose to invest in a low Market Cap to FCF Ratio Company. You just have to make sure that, business is not cyclical and Sales are growing.
The best yield-based valuation measure is a relatively little-known metric called FCF to Market Cap (inverse of Market Cap to FCF ratio).
This ratio is more potent than the PE ratio. One of the drawbacks of the PE ratio is, it takes in only accounting profit but not the real cash profit earned by the company. This ratio solves the problem.
Some companies may show a negative Market Cap to FCF ratio. This is not worrisome in some cases because the company has been reinvesting its money to grow the business and most business that grows might have negative FCF.