In a higher-for-longer interest rate narrative, it’s important to understand not just a business’ fundamentals but its stability. Enterprise value gives insight into a company’s ability to weather the current environment, including today’s high-rate environment. This is because the enterprise value of a company measures its market cap net its debt. This takes into account the price the company’s stock currently trades at as well as the cost of paying off all of its debts.
A rising rate environment has put a strain on businesses in the last two years, both from a profit and debt perspective. Evaluating a company’s overall health is crucial when looking for companies able to withstand persistent, elevated interest rates.
Why It’s Important to Include Enterprise Value When Determining Quality
Investors often look to a company’s market capitalization or valuation when investing. As noted above, it’s also important to assess this in relation to a company’s debt.
Companies increasingly feel the squeeze of higher rates when needing to borrow. Ensuring a company isn’t saddled with outsized debt compared to free cash flow (FCF) may reduce exposure to potential instability for investors. By avoiding these companies, investors can position their portfolios more defensively within equities.
Enterprise value is a core measurement used within the Victory U.S. Large Cap Free Cash Flow Index methodology when calculating FCF yield.
“Free cash flow is one of the most conservative of profitability estimates, in that it can account for the overall health of a company,” explained Michael Mack, associate portfolio manager for VictoryShares and Solutions.
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.
FCF yield is the free cash flow a company generates relative to the company’s market value. It is determined by dividing the amount of money remaining after paying capital and operating expenses by the enterprise value. Including a company’s debt allows this approach to potentially sidestep companies more susceptible to high rates because of high debt.
FCF Investing With VictoryShares
VictoryShares seeks to offer investors access to quality companies with high FCF yields through two of their ETFs. The VictoryShares Free Cash Flow ETF (VFLO) and the VictoryShares Small Cap Free Cash Flow ETF (SFLO).
The underlying indexes use a rules-based methodology to account for overall FCF and FCF yield. VFLO tracks the Victory U.S. Large Cap Free Cash Flow Index, while SFLO tracks the Victory U.S. Small Cap Free Cash Flow Index.
The index methodologies take into account both trailing and expected FCF, and as a result, the two indexes can provide exposure to companies with favorable forward-looking FCF estimates.
A growth filter is then applied to companies with the highest FCF yield, filtering for earnings and sales trends. Companies that make it into the underlying indexes exhibit high holistic FCF with favorable growth prospects.
VFLO has a net expense ratio of 0.39% (gross expense ratio of 0.66%). SFLO carries a net expense ratio of 0.49% (gross expense ratio 0.76%).
Net expense ratio reflects the contractual waiver and/or reimbursement of management fees through December 31, 2024.
VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO, for which it receives an index licensing fee. However, VFLO and SFLO are 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 and SFLO.
For more news, information, and analysis, visit the Free Cash Flow Channel.
Free cash flow (FCF) is a company’s net cash flow from operations minus capital expenditures.
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 Funds are new ETFs with a limited history. The Funds have 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 Funds invest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Funds may diverge from that of their Indexes. Investments in smaller companies typically exhibit higher volatility. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.
The Funds 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 Funds’ 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.
Additional Information
The Victory U.S. Small 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.
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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