As many look to alternatives strategies to hedge against potential market swings, ETF investors may consider a strategy that targets free cash flow to capture companies with organic growth.
“Focusing on free cash flow growth as our guiding metric allows us to get a true picture of the organic growth of a company,” TrimTabs Asset Management portfolio manager Janet Johnston said in a note. “It also allows us to avoid all of the ‘noise’ inherent in a company’s non-financial disclosures. We stay disciplined in our approach, which has been tried and tested over a number of years, and that allows us to create strong lists of high quality names.”
Free cash flow is the cash left over after a company has paid expenses, interest, taxes, and long-term investments. It is used to buy back stocks, pay dividends, or participate in mergers and acquisitions. The ability to generate a high free cash flow yield indicates a company is producing more cash than it needs to run the business, which can then be invested in growth opportunities.
Free Cash Flow Producing Companies
Free cash flow producing companies generally have three defining characteristics – they are productive, reliable and self sufficient. The companies generate more cash flow then they spend, which allows them to grow without external financing.
The free cash flow is sturdy measure of profitability than earnings, which are subject to manipulation and accounting assumptions. Lastly, as the companies are less reliant on capital markets for financing, they won’t dilute their issued company stocks.