What Is the Liability Adjusted Cash Flow Yield?

Liability Adjusted Cash Flow Yield (LACFY) is a fundamental analysis calculation that compares a company's long-term free cash flow (FCF) to its outstanding liabilities over the same period to produce a yield value. Liability adjusted cash flow yield can be used to determine how long it will take for a buyout to become profitable or how a company is valued. Because it is a yield (ratio), it can be used to compare between different firms, or analyze the same firm across time. Free cash flow yield gives investors another way to assess the value of a company that is comparable to the likes of the price-earnings (P/E) ratio. Since this measure uses free cash flow, the free cash flow yield provides a better measure of a company's performance. Since it is adjusted for liabilities, the LACFY gives an even better understanding of the true workings of a firm's finances.

Despite its appeal, liability adjusted cash flow yield is not commonly used in company valuation. To see whether an investment is worthwhile, an analyst may look at ten years worth of data in a LACFY calculation and compare that to the yield on a 10 year Treasury note. The smaller the difference between LACFY and the Treasury yield, the less desirable an investment is.

Liability Adjusted Cash Flow Yield is calculated as follows:

10-Year Average Free Cash Flow / (((Outstanding Shares + Options + Warrants) x (Per Share Price) + (Liabilities)) - (Current Assets - Inventory))

Understanding the Liability Adjusted Cash Flow Yield (LACFY)

Liability-adjusted cash flow yield (LACFY) is a formula for valuing common stocks, created by stock market commentator John DeFeo and inspired by Benjamin Graham and David Dodd. It is thought of as a formula that will provide the true ownership yield of a company with respect to modern accounting standards. The formula does have some limitations - it won't protect you from overvaluing a company with a large cash hoard overseas or an artificially-low tax rate (two accounting anomalies that often run hand-in-hand). Nor will it give you a fair valuation for a fledgling company with dramatic earnings growth (although, you can always modify the numerator to a best-guess cash flow figure).

When the financial crisis struck in 2009, companies that paid a dividend yield more than their LACFY seemed to be cutting their dividends with greater regularity than those that did not (examples include General Electric and Pfizer). Debt-laden companies with large liabilities had little recourse if they could not support their dividend with free cash flow and/or couldn't roll-over debt in a drying credit market. Based on this observation, DeFeo created a corollary pass/fail formula called the Dividend Acid Test:
Pass = Dividend yield less than LACFY
Fail = Dividend yield greater than LACF

An additional test was imposed relating this ratio to the yield from risk-free Treasury notes:

LACFY is greater than Dividend Yield is greater than 10-Year Treasury Yield.