How do I use EV/FCF for valuation comparisons?

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AcadiFi · Accepted Answer

EV/FCF (enterprise value divided by free cash flow to the firm) measures how many years of current FCF would be needed to pay back the total enterprise. It's often viewed as superior to EV/EBITDA because it accounts for working capital changes and capex needs — both of which EBITDA ignores.

For Meadowbrook Industrial: EV $3.2B, FCFF $240M. EV/FCF = 13.3x. Compare to peer EV/FCF median of 17x — suggests Meadowbrook is relatively cheap. Meanwhile EV/EBITDA might be 9x for Meadowbrook and 10x for peers, a smaller gap, because EBITDA doesn't penalize Meadowbrook's lighter capex profile.

When to use: (1) capital-intensive industries where capex assumptions matter materially, (2) comparing businesses with very different reinvestment rates, (3) assessing the true cash payback to investors, (4) sanity-checking EV/EBITDA conclusions.

Pitfalls: (1) FCFF is volatile period-to-period due to working capital swings — use normalized or 3-5 year average FCF. (2) Distinguish maintenance from growth capex for cleaner comparison. (3) FCFF can be temporarily boosted by working capital liquidation or capex deferral. (4) Companies with negative FCFF can't be meaningfully compared. (5) Acquisition accounting can distort the denominator via one-time transaction costs.

Forward EV/FCF using expected next-year FCF often works better than trailing, especially for companies where capex is lumpy or working capital is normalizing post-disruption. Always scrutinize the components of FCF before drawing conclusions.

How do I use EV/FCF for valuation comparisons?

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