In uncertain markets, investors can bolster portfolios with the stability offered by quality companies with solid free cash flow characteristics.
In the upcoming webcast, When Markets Wobble, Cash Remains King: Free Cash Flow Investing, Bob Shea, CEO and chief investment officer of FCF Advisors, and Vince (Qijun) Chen, portfolio manager and senior quantitative analyst at FCF Advisors, will outline a disciplined and consistent investment process driven by quantitative models to help financial advisors hone in on high-quality companies exhibiting high free cash flows.
For example, an effective way of accomplishing that goal is focusing on balance sheets. Some exchange traded funds, including the FCF US Quality ETF (TTAC) and the FCF International Quality ETF (TTAI), offer a way to do this. The “FCF” stands for “free cash flow.”
TTAC aims to outperform the Russell 3000 through a fundamentals-driven investment process that selects about 150 stocks based on free cash flow strength. Its holdings are then weighted by a modified market-cap log transformation, which allows for increased exposure to companies with the strongest proprietary free cash flow rankings.
TTAI, meanwhile, aims to outperform the MSCI All Country World Index ex the U.S. through an active investment process. A quant model is used to rank stocks based on proprietary measures of free cash flow. Highly leveraged firms, that incur debt to buy back shares, or don’t satisfy ESG criteria, are screened out. Roughly 150 of the highest-ranked stocks are selected and then weighted on a modified market-cap basis that factors in free cash flow and log transformation.
Both ETF portfolios will also be rated with an ESG score, excluding companies with low ESG ratings. Firms with an extreme rise in shares count and increase in leverage are excluded.
As we look to alternative strategies to hedge against potential market swings, investors may consider a strategy that targets free cash flow to capture companies with organic growth. Free cash flow is the cash left over after a company has paid expenses, interest, taxes, and long-term investments. It is used to buy back stocks, pay dividends, or participate in mergers and acquisitions. The ability to generate a high free cash flow yield indicates a company is producing more cash than it needs to run the business, which can then be invested in growth opportunities.
Free cash flow-producing companies generally have three defining characteristics: they are productive, reliable, and self-sufficient. The companies generate more cash flow than they spend, which allows them to grow without external financing.
The free cash flow is a sturdier measure of profitability than earnings, which are subject to manipulation and accounting assumptions. Lastly, as the companies are less reliant on capital markets for financing, they won’t dilute their issued company stocks.
Financial advisors who are interested in learning more about high-quality investment ideas can register for the Tuesday, August 30 webcast here.