Many investors often use earnings to measure a company’s profitability. But high free cash flow (FCF) yields can often indicate that a company is capable of sustaining long-term growth.
According to VictoryShares and Solutions Associate Portfolio Manager, Michael Mack, earnings can be “prone to accounting manipulation.” That’s why FCF yield may arguably be a better metric to gauge a stock’s growth potential.
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. Some investors believe it can also provide a better picture of a firm’s financial health than net income.
Generating More Cash Than Needed
In addition, companies with high FCF yields can tend to be self-sufficient. That’s because they generate more cash than they need to run their business.
“And this can be important in periods of volatility when issuing stock or debt can be very expensive,” Mack said on a webcast hosted by VettaFi. “Because they’re self-sufficient, they’re not reliant on the market for funding.”
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 Index¹.
The Index methodology looks to assess FCF based on a historic and forward-looking basis. The ETF’s Index identifies companies with a high FCF yield. These companies are then assessed based on a growth filter to eliminate some of the slower-growing names.
“You get value with quality characteristics,” Mack said. He added that within a comparison of the average annualized return and average annualized risk of FCF/EV to P/E, EV/Sales, EV/EBITDA, and P/B – FCF/EV has provided the best risk/return profile based on a 31-year period of analysis ended June 30, 2023².
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.
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/ Source: Victory Capital analysis sources through FactSet; Analysis period 12/31/1991-6/30/2023. Universe utilized for analysis is the S&P 500 Index with equal weighted constituents (excluding Financials and Real Estate).
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