We penalise companies which have low and deteriorating free cash flow margins relative to their industry peers as it suggests a deteriorating financial position. The free cash flow margin for our sample of 16,000 companies came in at a median average of 2.6% of sales between 2010 and 2015; however, there is significant variance by industry. Asset light industries, such as software and media, generate high free cash flow margins in excess of 5% of sales, as shown in Figure 93.
Our accounting screen is set to trigger a red flag when the free cash flow margin is in the lowest 20th percentile relative to GICS industry peers (i.e. it is very low), and/or when there is an abnormally large decrease relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in capex to sales is in the 20th percentile relative to the change experienced by industry peers between 2010 and 2015. For scoring purposes we reverse the percentile.
