Next, divide free cash flow by sales (or revenues), which tells you what proportion of each dollar in revenue the firm is able to convert into excess profits. If a firm’s free cash flow as a percentage of sales is around 5 percent or better, you’ve found a cash machine—as of mid-2003, only one-half of the S&P 500 pass this test. Strong free cash flow is an excellent sign that a firm has an economic moat.
