Potential economic slowing remains a top concern for many investors heading into the second half of 2024. Free cash flow (FCF) strategies offer one potential screen for those investors seeking reliable companies. Understanding the role of profits and capital expenditures (CapEx) in FCF measurements allows investors to make better-informed choices regarding FCF investing.
For context, CapEx are the funds a company uses to maintain, acquire, and upgrade its fixed assets. FCF is the remaining cash a company has after covering all expenses. It can be used to invest in growing the business, pay dividends or pay down debt.
Investors utilize FCF as one metric to understand a company’s financial health. A company’s FCF is made up of two parts. These include the cash earned from operations (profits) and the money it spends to buy, maintain, or improve operations (CapEx).
One concern around FCF investing involves relying on CapEx to generate a more attractive FCF measurement. The belief is that by reducing operating expenses and capital expenditures, a company can boost its FCF without needing to grow its profits. By this logic, FCF investors would gain exposure to companies with high FCF based on those companies reducing their operations/workforce/infrastructure, not on profitability and growth.
The VictoryShares Free Cash Flow ETF (VFLO) was designed to offer a potential solution to this issue. The ETF tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index). The Index seeks quality companies with high FCF yield¹, a measurement that considers a company’s enterprise value, which includes debt. FCF yield is calculated by dividing the cash left over after paying capital and operating expenses by the enterprise value.
VFLO: Combining FCF Yield and Growth Metrics
According to VictoryShares analysis sourced from FactSet, the Index generated FCF yields of 6.33% as of 06/05/24 over the last twelve months. During the same period, the S&P 500 Index generated FCF yields of 2.86%, while the Russell 1000 Value generated 3.21%.
Meanwhile, the Index yielded a long-term sales growth trend of 8.99% as of 06/05/24. This trend is measured as an average of 5-year historical and 2-year estimated forward sales growth. The S&P 500 yielded 11.48% long-term sales growth, and the Russell 1000 Value yielded 5.64% over the same period.
Although growing slightly slower than the S&P 500, the Index offers an initial FCF yield more than double that of the S&P 500. What’s more, it does so while still generating long-term sales growth of nearly 9%.
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. VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.
¹ FCF yield is based on the weighted average of index constituents and is equal to the expected FCF divided 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 and is often used as a more comprehensive alternative to equity market capitalization.
Disclosure Information
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.. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.
Additional Information
The Fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. 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. 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 Victory U.S. Large Cap Free Cash Flow Index aims to select high quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. 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.
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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