While free cash flow (FCF) may arguably be a better metric than earnings or income to gauge a company’s value, VictoryShares & Solutions contends that it’s a company’s projected future FCF, not its trailing FCF, that really matters.
FCF is the cash a company has after paying expenses, interest, and taxes, and has reinvested in the business. Its use includes buying back stock, paying dividends, or participating in mergers and acquisitions. FCF yield attempts to calculate how much cash flow a company generates relative to the cost of acquiring that business.
Forward-Looking Vs. Backward-Looking
During a webcast hosted by VettaFi, Michael Mack, Associate Portfolio Manager from VictoryShares and Solutions, noted that there are nearly 1,200 funds in the Morningstar Large Value Universe as of the most recent quarter end (Q2 2023). But of those funds, only a handful focus on free cash flow yield.
Mack has stated, “From what we’ve seen, only a handful appear to focus on free cash flow yield, and most use this metric from a backward-looking perspective only.” He added, “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.”
So, to identify companies most likely to have the most FCF in the future, Mack argued that “you need to take a forward-looking approach.” This involves taking a company’s trailing FCF and combining it with their forward FCF. Per Mack, the combination of these two is the best indication of where a company’s FCF is likely to fall in the future.
Capture Expected FCF With VFLO
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. This 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 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.
1/ This Index calculates free cash flow yield by dividing expected free cash flow by enterprise value. Expected free cash flow is the average of trailing 12-month FCF and next 12-month forward free cash flow. Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
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.
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