Free cash flow (FCF) is arguably a better metric than earnings or income to gauge a company’s value. However, it’s the company’s future FCF, not its trailing FCF, that really matters.
FCF represents the cash a company generates after accounting for cash payments to support operations and maintain its capital assets. It allows companies to reinvest cash, pay dividends, or repay debts. And when you look at the ratio of FCF relative to its market value in terms of FCF yield, it can provide a better picture of a firm’s financial health than net income.
“It’s the future FCFs that will drive a company’s value over time,” said VictoryShares and Solutions Associate Portfolio Manager, Michael Mack. “Therefore, incorporating forward-looking estimates can help give a clearer picture into their true valuations.”
It’s also important to note that a company’s FCF can significantly change year-over-year. Consider Moderna. The drug company’s FCF for 2021 was nearly $13.34 billion, up 580% from the year earlier. But in 2022, it dropped to $4.58 billion, a 65.7% decline.
Using both trailing and forward FCF would have been an alternative method of measuring the firm’s growth prospects. It also could have accounted for this decline better than only measuring its trailing FCF.
“Ultimately, we believe it’s the future free cash flows that will determine how a company fares going forward. Mack said. “It’s what the market anticipates.”
Targeting High FCF Yields
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 Index. 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 aims to select companies from the universe 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.
Forward free cash flow represents the cash that a company generates over some period of time in the future after accounting for cash outflows to support operations and maintain its capital assets based on consensus analyst estimates.
Trailing free cash flow measures a company’s free cash flow over a period of time. The cash flow for the previous 12 months is the most commonly used figure.
Free cash flow yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share and is calculated by taking the free cash flow per share divided by the current share price.
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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.
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.