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Why Enterprise Value Paints a Fuller Picture of a Company’s Free Cash Flow

Free cash flow (FCF) is the cash a company has after it’s paid its capital expenditures. It’s used to buy back stocks, pay dividends, or participate in mergers and acquisitions. But, a company with high FCF yields in the past may not necessarily have strong FCF yields going forward.

That’s why Michael Mack, Associate Portfolio Manager from VictoryShares and Solutions, argued that “you need to take a forward-looking approach” when seeking companies with high FCF yields. This involves taking a company’s trailing FCF and combining it with its forward FCF.

On a webcast hosted by VettaFi, Mack said the combination of a company’s trailing and forward FCF is the best indication of where its FCF is likely to be in the future. “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,” Mack added.

Target Profitable Companies With High FCF Yields

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, which 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.

“Enterprise value looks at the company’s entire capital structure,” Mack said. “And so, its not just its market value…it also looks at the debt and cash it has on its balance sheet.”

Tilting Towards Companies With Stronger Balance Sheets

Mack explained that a highly leveraged company “might appear cheap on a trailing free cash flow yield basis.” But that’s because “they have a lot of debt on their balance sheet. And once you factor in that debt, you see they’re no longer cheap.”

“By using enterprise value, at the end of the day, it’s going to tilt you towards companies with stronger balance sheets,” Mack said. “Which is one of the ways we see free cash flow being a more resilient factor over time.”

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.

Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.

1/ This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. You cannot invest directly in an index.

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.

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.

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.

Additional Information

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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