When measuring a company’s free cash flow (FCF) yield, its trailing FCF isn’t what matters. We believe it’s the forward FCF. FCF is the cash a company has after paying expenses, interest, and taxes, and has reinvested in the business. It can be used to buy back stock, pay dividends, or participate in mergers and acquisitions.
FCF yield attempts to calculate how much cash flow a company generates relative to the cost of acquiring that business. And according to Victory Capital’s Associate Portfolio Manager, Michael Mack, forward FCF offers a better indicator of a company’s long-term potential.
“We believe it’s the forward free cash flows that will drive a company’s value over time,” Mack said. “Therefore, incorporating forward-looking estimates can help give a clearer picture of its true valuations.”
See more: “Is Free Cash Flow the Most Relevant Metric for Profitability?”
A Case Study on Forward FCF
Consider an American steel production company. This business is a cyclical company that often sees large swings in FCF based on changing economic conditions.
If one were to measure its current trailing 12-month FCF as of 6/15/20231, it would appear that they had a 14.3% yield. However, based on consensus analyst estimates, their next 12-month FCF may drop roughly 60%, leaving them with an FCF yield of 4.3%.
“Ignoring forward-looking estimates can lead you to buy a company based on past results that may not reflect the future free cash flow potential,” Mack said.
For investors looking to target companies with high FCF yields, the VictoryShares Free Cash Flow ETF (VFLO) may be worth looking into.
Launched last month, VFLO tracks an index focused on large-cap companies with high free cash flows that are then filtered to select those with the most favorable growth prospects using trailing and forward-looking metrics.
For more news, information, and strategy, visit the Free Cash Flow Channel.
1/ Source: FactSet
Free cash flow (FCF) represents the cash that a company generates after accounting for cash outflows to support operations and maintain its capital assets.
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.
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