Experienced investors know that there’s no such thing as a sure thing in financial markets. Nor is there any strategy that 100% insulates portfolios from downside risk, except cash.
Fortunately, there are steps that investors can take to minimize such risks. An effective way of accomplishing that goal is focusing on balance sheets. Some exchange traded funds, including the FCF US Quality ETF (TTAC), offer a way to do this. The “FCF” in TTAC’s name stands for “free cash flow.”
Novice investors take heart because free cash flow is easy to define. Simply put, it’s the capital a company has left over that’s not used for expenses or to tend to other liabilities. Not all companies generate free cash flow in comparable fashion, confirming the utility of an ETF such as TTAC.
Another point to consider with TTAC is that emphasis on free cash flow as a useful evaluation metric built over time, and it arguably has more momentum and staying power today than ever before.
“The trend toward wider acceptance of this yard-stick has been building since the early 1970s. Accelerating the trend have been several developments—including new financial reporting rules on such issues as foreign currency translation, equity earnings, interperiod income tax allocation, and lease and interest cost capitalization—that put greater distance between a company’s net income and its cash flow; the adoption of ‘liberal’ accounting practices by some companies; and record inflation levels,” according to a 1984 article in the Harvard Business Review.
That article makes some points about varying, complex accounting standards, some of which are still employed today. The point is, some companies “game” the system when it comes to accounting. That’s another reason a fund like TTAC is attractive. Either a company is generating free cash flow or it’s not — it’s not a trait that can be “fudged” on the balance sheet.
Adding to the allure of TTAC both as a near-term idea and as a long-term investment is the fact that many companies that are prodigious generators of free cash flow often make shareholder rewards — buybacks and dividends — a priority. Companies that can fund dividends via free cash flow are less likely to be dividend offenders and more likely to be steady payout growers over time.
For more news, information, and strategy, visit the Free Cash Flow Channel.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.