Advisors and investors concerned about equity valuations and stability in high-rate environments may be looking to free cash flow companies for opportunity. Growth is an important factor to also assess when considering high free cash flow-yielding companies, but faster growth isn’t always better when viewed in isolation.
Free cash flow (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.
Quality companies may offer the potential for dependable income and reliable performance in various market conditions. Companies with high FCF yield could prove resilient to elevated rates in the current environment.
The Tortoise and the Hare: The Starting Point Matters
Investors in the S&P 500® Index appreciate the growth potential of this broad equity index. With a long-term sales growth of 10.74%¹, it’s no wonder why the S&P 500 remains popular. However, looking for high FCF, quality companies in a growth-oriented index, like the S&P 500 may prove challenging.
The VictoryShares Free Cash Flow ETF (VFLO) invests in quality companies with high FCF yield and tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index). The Index offers a long-term sales growth of 9.07%¹. What the strategy lacks in growth speed, it makes up for with its starting point for FCF.
FCF yield considers a company’s enterprise value or its total value, including debt. It’s calculated by dividing the cash left over after paying capital and operating expenses by the enterprise value.
The Index generated an FCF yield of 6.82%² as of 3/31/2024. Over the same period, the S&P 500 generated an FCF yield² of 3.27%². For reference, the ETF’s benchmark, the Russell 1000® Value Index, offered a long-term sales growth of 5.74%¹ and an FCF yield of 3.61%².
Image source: VictoryShares
“The S&P 500 is growing at a faster rate,” explained Todd Rosenbluth, head of research at VettaFi. However, “because the Index which VFLO tracks starts at more than double the FCF yield of the S&P, it would take the S&P investors much longer to capture the same cash flow.”
Value Investing with a Growth Tilt
When screening companies, VFLO’s methodology calculates FCF holistically by including both trailing and expected FCF. The Index also applies a growth filter intended to eliminate companies with high FCF but with weak growth prospects.
VFLO carries a net expense ratio of 0.39% and a gross expense ratio of 0.66%.
Net expense ratios reflect the contractual waiver and or reimbursement of management fees through at least December 31, 2024.
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/ Long term sales growth as of 3/31/2024, calculated using a 5-year historical average and 2-year forward estimates
²/ 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. 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 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.
Additional Information
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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