Profitable companies with high free cash on hand are able to diversify and return value back to investors. Those who are interested in the investment theme can target these high free-cash-flow companies through exchange traded funds.
On the recent webcast, Free Cash Flow: What It Means for Investors, Charles Biderman, chairman and portfolio manager at TrimTabs, explains the free cash flow investment theme as a way to identify companies that are able to reinvest into new opportunities or generate value for investors through buybacks and dividends.
For instance, the actively managed TrimTabs Float Shrink ETF (NYSEArca: TTFS) highlights U.S. companies with better free cash flow while the recently launched TrimTabs International Free-Cash-Flow ETF(NYSEArca: FCFI) takes the same theme across the international markets.
The free cash flow is the leftover cash after accounting for operating expenditures, research and development, capital expenditures and new business ventures, along with adding back depreciation and non-cash charges.
“Generating free cash flow is the ultimate purpose for any business, Biderman said. “This cash can either be retained on the balance sheet, invested in future new ventures and/or returned to shareholders via stock buybacks or dividends. As such, it’s worth recognizing that free cash flow is a reliable metric by which to gauge a company’s financial performance.”
The free cash flow yield, or a company’s free cash flow divided by market capitalization, provides a strong indicator of balance sheet strength and a company’s current cash flow positions. Typically, investors would want to look for companies with high cash flow percentage, which reflects higher cash flow with the same underlying valuation.
Looking at the ETF options, TTFS focuses on U.S. stocks and tries to generate excess returns to the Russell 3000 Index, with less volatility than the index. The managers will select companies that finance float shrink, or a reduction in publically traded shares through buybacks, using free cash flow. Year-to-date, TTFS has outperformed the broader markets, rising 5.3%, compared to the 4.1% gain in the Russell 3000.
TrimTabs also tries to steer away from companies that buyback stocks and give the stocks right back to executives.