Use Free Cash Flow to Avoid Hollywood Accounting

In the entertainment industry, there’s a term known as “Hollywood accounting.” It is the practice of manipulating how profitable (or unprofitable) a movie, show, or record album is through creative bookkeeping methods. This practice can inflate or reduce costs, allowing film studios to claim bona fide blockbusters as flops.

It’s not just Hollywood that engages in this type of manipulative bookkeeping. Clever accounting can misrepresent earnings statements from any company in any industry. This can make it difficult to gauge how profitable a company truly is.

A company’s earnings statements can be manipulated through so-called Hollywood accounting practices but, its free cash flow cannot.

See more: “Forward Free Cash Flow Vs. Trailing Free Cash Flow

A More Accurate Snapshot

After a company has paid expenses, interest, and taxes, and has reinvested in the business, free cash flow is what remains. Companies use free cash flow to reinvest cash, pay dividends, or repay debts. It also arguably provides a more comprehensive and accurate snapshot of a company’s potential profitability.

“It reflects actual cash generated by a business and is less subject to manipulation,” Michael Mack, Associate Portfolio Manager for VictoryShares and Solutions said. “We believe this is ultimately what matters.”

The VictoryShares Free Cash Flow ETF (VFLO) invests in profitable U.S. large-cap companies with high free cash flow yields. The ETF seeks to provide investment results that track the performance of the Victory U.S. Large Cap Free Cash Flow Index1 (the Index).

The Index screens an initial universe2 of large-cap companies, excluding those classified as Financials and Real Estate, using a combination of trailing and forward-looking free cash flow. Then, it eliminates companies with the worst growth characteristics to seek better outcomes in various market environments.

This results in a 50-stock portfolio consisting of companies with the highest combination of free cash flow yields and growth rates3 included in the Index. The Index is reconstituted and rebalanced every quarter.

For more news, information, and strategy, 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.


Disclosure Information

Free cash flow (FCF) represents the cash that a company generates after accounting for cash outflows to support operations and maintain its capital assets.

1/ 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.

2/ The Victory U.S. Large Cap Free Cash Flow Index’s starting universe is the VettaFi 1000 Index which consists of market cap weighted U.S. large-cap stocks.

3/ Growth rate is defined as the long-term sales growth trend defined as an average of 5-years historical and 2-years forward sales growth

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. 

Additional Information

 All investing involves risk, including the potential loss of principal. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions have limits, and commissions often charge 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 concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors.

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.

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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