If you are currently a shareholder in Somfy SA (EPA:SO), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. I will take you through SO’s cash flow health and the risk-return concept based on the stock’s cash flow yield, using the most recent financial data. This will help you think about the company from a cash perspective, which is a crucial factor to investing.

View our latest analysis for Somfy

What is free cash flow?

Somfy’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Somfy to continue to grow, or at least, maintain its current operations.

There are two methods I will use to evaluate the quality of Somfy’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.

Free Cash Flow = Operating Cash Flows – Net Capital Expenditure

Free Cash Flow Yield = Free Cash Flow / Enterprise Value

where Enterprise Value = Market Capitalisation + Net Debt

Somfy’s yield of 3.93% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Somfy but are not being adequately rewarded for doing so.

Is Somfy’s yield sustainable?

Does SO’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. In the next few years, expected growth for SO’s operating cash is negative, with operating cash flows expected to decline from its current level of €184m. This is unfavourable to its future outlook, especially if capital expenditure heads the opposite direction. However, breaking down growth into a year on year basis, SO ‘s negative growth rate improves each year, from -2.3% next year, to 2.3% in the following year.

Next Steps:

Low free cash flow yield means you are not currently well-compensated for the risk you’re taking on by holding onto Somfy relative to a well-diversified market index. Moreover, the stock’s negative growth prospects in terms of cash flow, seems worrisome. Now you know to keep cash flows in mind, I suggest you continue to research Somfy to get a better picture of the company by looking at:

1. Valuation: What is SO worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SO is currently mispriced by the market.

2. Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Somfy’s board and the CEO’s back ground.

3. Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.