S&P 500 And Sectors: Free Cash Flow Yield Rises Above Pre-Pandemic Levels

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This report[1][2] is an abridged version of S&P 500 & Sectors: Free Cash Flow Yield Rises above Pre-Pandemic Levels, one of our quarterly series on fundamental market and sector trends.

S&P 500 FCF Yield in Q4 Rose above Pre-Pandemic Levels

2021 was a very profitable year for the S&P 500. Cash flows rose faster than stock prices as the index’s free cash flow (FCF) yield rose to its highest level since 12/31/18. The trailing FCF yield for the S&P 500 rose from 1.1% on 3/31/21 to 2.2% as of 3/11/22. Before the pandemic, the FCF yield for the S&P 500 was 2.0% on 3/31/20.

Nine S&P 500 sectors saw an increase in trailing FCF yield from 3/31/21 to 3/11/22.

Key Details on Select S&P 500 Sectors

With a 6.8% FCF yield, investors are getting more FCF for their investment dollar in the Basic Materials sector than any other sector. On the flip side, the Real Estate sector, at -4.1%, currently has the lowest trailing FCF yield of all S&P 500 sectors.

The Basic Materials, Financials, Industrials, Healthcare, Telecom Services, Utilities, Consumer Cyclicals, Energy, and Consumer Non-cyclicals sectors each saw an increase in trailing FCF yield from 3/31/21 to 3/11/22.

Below, we highlight the Industrials sector.

Sample Sector Analysis: Industrials

Figure 1 shows trailing FCF yield for the Industrials sector rose from 0.0% as of 3/31/21 to 2.9% as of 3/11/22. The Industrials sector FCF rose from -$1.1 billion in 2020 to $120.0 billion in 2021, while enterprise value fell from $4.3 trillion as of 3/31/21 to $4.1 trillion as of 3/11/22.

Figure 1: Industrials Trailing FCF Yield: December 2004 – 3/11/22

S&P 500 Industrials Trailing FCF Yield (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The March 11, 2022, measurement period uses price data as of that date and incorporates the financial data from 2021 10-Ks, as this is the earliest date for which all the 2021 10-Ks for the S&P 500 constituents were available.

Figure 2 compares the trends in FCF and enterprise value for the Industrials sector since 2004. We sum the individual S&P 500/sector constituent values for free cash flow and enterprise value. We call this approach the “Aggregate” methodology, and it matches S&P Global’s (SPGI) methodology for these calculations.

Figure 2: Industrials FCF & Enterprise Value: December 2004 – 3/11/22

S&P 500 Industrials FCF & Enterprise Value (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The March 11, 2022, measurement period uses price data as of that date and incorporates the financial data from 2021 10-Ks, as this is the earliest date for which all the 2021 10-Ks 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, we 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 Industrials sector’s trailing FCF yields.

Figure 3: Industrials Trailing FCF Yield Methodologies Compared: December 2004 – 3/11/22

S&P 500 Industrials Trailing FCF Yield Analysis (New Constructs, LLC)

Sources: New Constructs, LLC and company filings. The March 11, 2022, measurement period uses price data as of that date and incorporates the financial data from 2021 10-Ks, as this is the earliest date for which all the 2021 10-Ks for the S&P 500 constituents were available.

This article originally published on April 1, 2022.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

Appendix: Analyzing Trailing FCF Yield with Different Weighting Methodologies

We 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. We 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 calculates metrics for the S&P 500.

For additional perspective, we 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 we include them here, nonetheless, for comparison:

  1. 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. We 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
  2. 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. We multiply each company’s free cash flow and enterprise value by its weight
    3. We 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.

[1] We calculate these metrics based on S&P Global’s methodology, which sums the individual S&P 500 constituent values for market cap and economic book value before using them to calculate the metrics. We call this the “Aggregate” methodology.

[2] Our research is based on the latest audited financial data, which is the 2021 10-K for most companies. Price data is as of 3/11/22.