Home etftrends.com The Significance of Free Cash Flow in Company Valuations

The Significance of Free Cash Flow in Company Valuations

Free cash flow (FCF) represents the cash a company can produce after removing the purchase of assets such as property, equipment, and other major investments from its operating cash flow. FCF measures a company’s ability to produce cash that can be distributed in a discretionary way.

Knowing a company’s FCF lets management decide which future ventures would improve shareholder value. An abundant amount of FCF also shows that a company is generating more cash than it needs. Companies can also use their FCF to expand business operations or pursue other investments.

So, when measuring a company’s growth potential, FCF could serve as a better metric than earnings.

See more: “How Dividend Growth & Free Cash Flow Go Hand in Hand”

According to the Corporate Finance Institute[1], “Other entities looking to invest may likely consider companies that have a healthy free cash flow because of a promising future.” It goes on to state, “Couple this with a low-valued share price, investors can generally make good investments with companies that have high FCF. Other investors greatly consider FCF compared to other measures because it also serves as an important basis for stock pricing.”

Seeking Companies With High Free Cash Flows

The VictoryShares Free Cash Flow ETF (VFLO) targets large-cap companies with high free cash flows. It seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index[2]. The Index methodology assesses free cash flow (FCF) based on a historic and forward-looking basis.

During a webcast hosted by VettaFi, Michael Mack, Associate Portfolio Manager for VictoryShares and Solutions, stated “future cash flow is a function of the growth rate.”

“Everything in this strategy is designed to point to what ultimately determines a company’s value,” he said.

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. Financials and real estate are excluded.

From the starting universe, the 400 largest profitable companies are selected. VFLO’s Index then applies an expected free cash flow[3] screen, where the 75 companies with the highest expected FCF are selected. The Index selects the top 50 stocks with the highest expected growth score, and holdings are then weighted based on the size and yield of a company’s FCF.

“This offers the ability to get value without sacrificing relative growth value potential,” Mack added.

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.


Notes

[1] https://corporatefinanceinstitute.com/resources/valuation/what-is-free-cash-flow-fcf/

[2] 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.

[3] Expected FCF is the average of the trailing 12-month FCF and the next 12-month forward FCF.

Disclosure Information

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.

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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