While free cash flow (FCF) may arguably be a better metric than earnings or income to gauge a company’s value, VictoryShares & Solutions contends that it’s a company’s projected future FCF, not its trailing FCF, that really matters.
FCF is the cash a company has after paying expenses, interest, and taxes, and has reinvested in the business. Its use includes buying back stock, paying dividends, or participating in mergers and acquisitions. FCF yield attempts to calculate how much cash flow a company generates relative to the cost of acquiring that business.
Forward-Looking Vs. Backward-Looking
During a webcast hosted by VettaFi, Michael Mack, Associate Portfolio Manager from VictoryShares and Solutions, noted that there are nearly 1,200 funds in the Morningstar Large Value Universe as of the most recent quarter end (Q2 2023). But of those funds, only a handful focus on free cash flow yield.
Mack has stated, “From what we’ve seen, only a handful appear to focus on free cash flow yield, and most use this metric from a backward-looking perspective only.” He added, “It’s important to understand that at the end of the day the value of a business is based on its potential future cash flows.”
So, to identify companies most likely to have the most FCF in the future, Mack argued that “you need to take a forward-looking approach.” This involves taking a company’s trailing FCF and combining it with their forward FCF. Per Mack, the combination of these two is the best indication of where a company’s FCF is likely to fall in the future.
Capture Expected FCF With VFLO
The VictoryShares Free Cash Flow ETF (VFLO) invests in profitable U.S. large-cap companies with high FCF yields. The ETF seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index1. This Index calculates FCF yield by dividing expected FCF by enterprise value.
Expected FCF is the average of the trailing 12-month FCF and the next 12-month forward FCF. Enterprise value measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
The Index methodology selects companies from a universe2 of U.S. large-cap stocks by applying a profitability screen. It then selects companies with the highest free cash flow yields that exhibit relatively higher growth potential based on trailing and forward-looking metrics.
For more news, information, and analysis, visit the Free Cash Flow Channel.
VettaFi LLC (“VettaFi”) is the index provider for VFLO, for which it receives an index licensing fee. However, VFLO is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.
1/ This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
2/ The Victory U.S. Large Cap Free Cash Flow Index’s starting universe is the VettaFi 1000 Index which consists of market cap weighted U.S. large-cap stocks.
Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. To obtain a prospectus or summary prospectus containing this and other important information, visit http://www.vcm.com/prospectus. Read it carefully before investing.
All investing involves risk, including the potential loss of principal. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The Fund invests in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Fund may diverge from that of the Index. Investments concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors. Derivatives may not work as intended and may result in losses.
Large shareholders, including other funds advised by the Adviser, may own a substantial amount of the Fund’s shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. Investments in mid-cap companies typically exhibit higher volatility. The value of your investment is also subject to geopolitical risks such as wars, terrorism, environmental disasters, and public health crises; the risk of technology malfunctions or disruptions; and the responses to such events by governments and/or individual companies.
The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. The securities highlighted, if any, were not intended as individual investment advice.
Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.|
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