Many use market capitalization to gauge a company’s valuation and growth potential. However, during a webcast hosted by VettaFi, Michael Mack, Associate Portfolio Manager for VictoryShares and Solutions, noted how market capitalization can sometimes be misleading.
If an investor were to just look at the market cap of a highly leveraged business, they could “be fooled into thinking they’re very attractively valued,” according to Mack. But “when you adjust for debt, you see that they’re no longer attractively valued.”
Mack suggested that free cash flow (FCF) may be a far better measuring stick to determine value. “The value of a business is based on its potential future cash flows,” he said.
See more: “Sectors Like Healthcare Take Center Stage in the VFLO Index’s Pursuit of Value”
VFLO Takes a Forward-Looking Approach to Free Cash Flow
FCF is the cash that a company has after paying its capital expenditures. Then, the company uses it to buy back stocks, pay dividends, or participate in mergers and acquisitions.
The VictoryShares Free Cash Flow ETF (VFLO) invests in profitable U.S. large-cap companies with high FCF yields. VFLO seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow 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. Additionally, enterprise value measures a company’s total value and is often used as a more comprehensive alternative to equity market capitalization.
The Index methodology selects companies from a universe 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.
 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.
The index measures FCF yield by dividing expected free cash flow by enterprise value. Expected FCF is the average of trailing 12-month FCF and next 12-month forward FCF. Universe utilized for analysis is the S&P 500 Index with equal weighted constituents (excluding Financials and Real Estate). Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value includes in its calculation the market capitalization of a company but also short-term and long-term debt and any cash on the company’s balance sheet.
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. Please note that the fund is a new ETF with a limited history. 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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