While it is possible to argue that free cash flow (FCF) is a better metric to gauge a company’s growth potential than market capitalization, it’s important to note that not all high FCF yields are the same. VictoryShares and Solutions Associate Portfolio Manager Michael Mack said that some companies have higher FCF yields, reflecting their slower growth potential.
“In these cases, the higher FCF yield reflects these lower growth prospects,” Mack said. “It’s important to incorporate forward-looking measures to determine how attractive a company’s FCF yield is relative to its growth.”
See more: Looking Beyond Market Cap: Does Free Cash Flow Redefine How to Assess Company Value?
Cash Rich, But Slow Growth
Consider Cisco. The technology firm has been a very profitable, cash-rich company. But the challenge now is that faces slowing growth compared to the market. According to FactSet, Cisco has grown revenues 2.9% annually over the past 5 years, which compares to the S&P 500 at 6.3% over the same time frame1.
This is why the VictoryShares Free Cash Flow ETF (VFLO ) applies a growth filter to eliminate some slower-growing names. VFLO targets large-cap companies with high free cash flows and favorable growth prospects. It seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index2. The Index methodology assesses FCF based on a historical and forward-looking basis.
The outcome is a 50-stock portfolio consisting of companies with the highest combination of free cash flow yields and growth rates3 to be included in the Index, which is reconstituted and rebalanced every quarter.
“All else equal, we believe it would be better to invest in other companies with similar FCF yields but higher growth rates,” Mack added.
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.
Notes
Free Cash Flow (FCF) is the cash a company generates that is available for distribution to investors, debt repayment, or reinvestment in the business.
As of 12/18/2023 the VictoryShares Free Cash Flow ETF did not own or hold any position in Cisco.
1 Source: FactSet as of 12/17/2023
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.
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.
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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.
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