Free cash flow is a useful metric for evaluating companies and investment opportunities.
Free cash flow is the remaining cash a company has after accounting for operating expenses and capital expenditures. This calculation takes place after a company has paid its expenses, employees, taxes, interest, and even reinvestments. The value of a company is the present value of its future free cash flow.
While free cash flow represents a company’s ability to grow its business, pay dividends, or pay down debt, some firms may use different methods to assess free cash flow. Notably, a fund like the VictoryShares Free Cash Flow ETF (VFLO) takes a more conservative approach to assessing free cash flow.
For example, some conventional formulas (including from the CFA Institute) do not include borrowing costs when calculating free cash flow, while VFLO’s approach incorporates them. This allows VFLO to look at the free cash flow of a company net of interest and taxes.
According to Michael Mack, Associate Portfolio Manager for VictoryShares and Solutions, ignoring borrowing costs may not make the most sense. “For stocks to have any value, a company needs to pay the interest on their bonds.”
Why Should Funds Assess Free Cash Flow?
Positive free cash flow means a company generates more cash than it needs to cover all its expenses. This excess cash is commonly used for dividends and buybacks. It can also be used for M&A activity, which is seen to a lesser extent.
“Companies with strong free cash flow have the ability to reward shareholders with dividends or share repurchases,” said Todd Rosenbluth, head of research at VettaFi. “In addition, they can use cash to make acquisitions.”
VFLO provides exposure to high-quality U.S. large-cap companies. The fund considers a company’s expected free cash flow rather than just trailing free cash flow. This means VFLO targets companies with high free cash flow yield and the highest growth rates.
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.
For more news, information, and analysis, visit the Free Cash Flow Channel.
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Additional Information
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.
Distributed by Foreside Fund Services, LLC (Foreside). There is no affiliation between Foreside and Victory Capital Management Inc. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.
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