Here's how to pick stocks using two metrics that modern value investors are starting to use: Free Cash Flow Yield and Return on Invested Capital.
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Timestamps:
0:00 - Start Here
0:30 - Growth Investing Has Been Outperforming Value
1:50 - What is Value Investing?
3:07 - Modern Value Investing
4:24 - Free Cash Flow Yield
6:55 - Return on Invested Capital (ROIC)
9:52 - Valuebreaker Spreadsheet



Value investing as you may know it today was popularized by Benjamain Graham, author of the Intelligent Investor. Benjamin Graham's methodology for value investing eventually formed Warren Buffett's investment methodology which is, in plain English...
1. To look for companies trading below their true value and investing in these companies for the long term until the market recognizes their true value.
2. Benjamin Graham and Warren Buffett looked at metrics such as "Price to Book Value", Price to Earnings Growth (PEG) ratio, and current ratios back then, but times have changed, that's not to say we still shouldn't pay attention to some of these metrics, but there are some revamped metrics we should consider during modern times.

Instead of price to book value, I'd like to introduce to you Free Cash Flow Yield and Return on Invested Capital.

Free Cash Flow Yield takes one of Warren Buffet's favorite metrics:
Free Cash Flow and converts it to a percentage, or yield, per share. As mentioned in previous videos, a company can make millions or billions of dollars in revenue but they could be using so much cash to generate that revenue that they are actually operating cash negative.

We want to look for companies operating at cash flow positive. When your company is cash flow positive, it means your making more money than its using - which is a good thing when evaluating the strength of a business.

Free Cash Flow Yield is important because companies that are strong, don't need to spend more than they earn to maintain their competitive position.

Warren Buffet popularized investing in companies that had "moats" which is a fancy way of saying a competitive advantage over their competitors.

Free Cash flow yield is represented by the equation: FCF / Market Cap

Generally, we want to aim for Free Cash Flow Yields of greater than 5.00%. This is because the Average FCF yield in the market is 5% so anything above 5% is good.

Return on Invested Capital or ROIC is the return (or profit) and company makes on its investments.

When we're investing in companies, we want to make sure that their investments they're making are ROI positive, if they're making money on their investments, it's only logical that the shareholders will in turn hopefully be profitable down the line.

Let's use Apple. Apple released the new iPhone 12 last October. If Apple spent around $700 per phone all in (including shipping, marketing, other fees), and sold each phone for $999, Apple's ROIC on this project (iPhone's) would be 29%.

ROIC is a metric that essentially ensures that a company can consistently invest in profitable projects now and into the future.

Low ROIC companies often have few profitable investing opportunities and therefore have little opportunity to generate shareholder wealth.

ROIC is arguably one of the most important metrics when it comes to institutional investing (i.e., investment managers that get paid millions of dollars to manage money) because it is an all-encompassing number.


▶️ My name is Humphrey Yang, I've built multiple businesses and am passionate about Personal Finance. If you're trying to build a solid foundation of financial literacy, learn to invest, or become financially free - then I'm here for you! This channel cover topics like getting out of debt, managing money, building credit, multiple income sources, passive income, etc.

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