Dividend strategies have been popular for years. Arguably, the source of those sustainable dividend payments is strong free cash flow (FCF). [1]
FCF is the cash a company has after it reinvests in the business and has paid its expenses, interest and taxes. Its use includes buying back stock, paying dividends, or participating in mergers and acquisitions. FCF yield attempts to calculate how much cash flow a company generates relative to the cost of acquiring that business.
VictoryShares and Solutions Associate Portfolio Manager Michael Mack stated over time he continually witnesses dividend growth going “hand-in-hand” with FCF yield.
“We actually think looking at free cash flow is a great way to identify dividend growth potential,” he said on a webcast hosted by VettaFi. “Dividends are ultimately paid from cash flow. If you’re going to sustainably pay and grow a dividend, you need to have free cash flow over time.”
See more: “Why Companies With Strong Free Cash Flow Are Often Self-Sufficient”
Price Appreciation Matters
Additionally, price appreciation is a factor investors in dividend strategies may want to keep in mind. Mack offered an example of two theoretical funds with the same dividend yield, but with different price appreciations. Let’s say one fund has a price appreciation of 100% and the other fund has 200%. If they are both providing a dividend yield of 2%, the yield from the second fund with the higher price appreciation would provide more income.
“That dividend yield will be much higher. There is a difference between dividend yield and a portfolio’s dividend income. When two investments have the same yield, it’s the price appreciation that will drive the dividend income the fund pays out,” Mack told VettaFi.
Profitable Companies With High FCF Yields
For investors wanting to invest in profitable U.S. large-cap companies with high FCF yields, the VictoryShares Free Cash Flow ETF (VFLO) may be what they’re looking for. The ETF seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index [2].
The Index methodology assesses FCF based on a historic and forward-looking basis. The ETF’s Index identifies companies with high FCF yields. There is then an application of growth filters to these companies to eliminate those where free cash flow is high because of weak growth prospects.
Past performance does not guarantee future results.
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, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.
Important Disclosures
[1] CFA Institute, “Free Cash Flow Valuation,” https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/free-cash-flow-valuation
[2] 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. You cannot invest directly in an index.
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Additional Information
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. Investments in mid-cap companies typically exhibit higher volatility. 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.
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The information in this article is based on data obtained from recognized services and sources and is believed to be reliable. The securities highlighted, if any, were not intended as individual investment advice.
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