Free cash flow (FCF) is the cash a business has left over after it has paid its capital expenditures¹ (capex). Some see FCF as a better metric for measuring a company’s profitability. Not only that, but it can also be a reliable indicator of a sector’s profitability.
Consider the energy sector. The FCF yields of companies in the sector have traditionally swung based on oil prices.
After the summer of 2020, when oil prices went negative, companies became considerably more cautious about their capex spending. Since then, the industry has cut back on capex. Now, no one is spending money to boost production.
“This lack of supply, coupled with higher demand, has caused oil prices to increase,” said Michael Mack, Associate Portfolio Manager at VictoryShares and Solutions. “The combination of higher oil prices and lower capex has translated into record free cash flow for the sector.”
Today, the sector has been trading at the most attractive levels in the past 30 years from an FCF yield perspective.
“It’s a great example of how the amount of free cash flow a sector generates can be a reflection of the supply and demand dynamic of that sector,” Mack added.
Target Companies and Sectors With Strong FCF Yields
Investors seeking profitable U.S. large-cap companies with high FCF yields should look into the VictoryShares Free Cash Flow ETF (VFLO). The ETF seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index (the Index). The 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 aims to select 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/ Capital expenditure is the money a business or organization spends on acquiring or maintaining fixed assets, such as land, buildings, and equipment.
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.
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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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