Home etftrends.com Why Truly Profitable Companies Generate Excessive Free Cash Flow

Why Truly Profitable Companies Generate Excessive Free Cash Flow

Traditional value metrics like book value convey how much capital a company has invested in the business. But the sign of a truly profitable business is that it generates more free cash flow (FCF) than it needs.

FCF is the cash a business has left over after it has paid its capital expenditures. Historically, a company generating a lot of FCF has been a sign of a business with a sustainable competitive advantage.

See more: “Why Price-To-Book Ratio Doesn’t Reflect a Company’s True Value

Sectors Generating the Most FCF

According to Michael Mack, Associate Portfolio Manager at VictoryShares and Solutions, the technology, consumer, and healthcare sectors have generated the most FCF over the past 30 years.

“These are sectors where the value of the business comes from intangible assets and intellectual property like an innovative patent or a strong customer brand,” Mack said.

Meanwhile, sectors like financials, energy, and utilities are commoditized. As Mack explained, those sectors have more of a level playing field, so it’s hard for companies to differentiate themselves. Therefore, they don’t tend to generate very much FCF.

“Oil is oil with little differentiation in who is drilling to get it,” Mack said. “Same with electricity or a loan from the bank.”

Targeting These Profitable Businesses With VFLO

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 universe of U.S. large-cap stocks1 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.


Disclosure Information

1/ 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.

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.

Book value is the sum of the amounts of all the line items in the shareholders’ equity section on a company’s balance sheet. You can also calculate book value by subtracting a business’s total liabilities from its total assets.

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.

Additional Information

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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