Investors in small caps should not overlook free cash flow (FCF) as a valuable metric for evaluating investment opportunities.
FCF is the remaining cash a company has after accounting for operating expenses and capital expenditures. It represents a company’s ability to grow its business, pay dividends, or pay down debt.
FCF may be a particularly important metric in the small-cap space. Typically, small caps do not generate as much FCF as their large-cap peers. In fact, more than 40% of small caps in the Russell 2000 Index are unprofitable1.
Furthermore, the small caps that succeed in generating strong FCF tend to exhibit higher quality and lower valuations – potentially attractive attributes for an investment.
Potential Solution for Small-Cap Exposure with Strong Free Cash Flow
The VictoryShares Small Cap Free Cash Flow ETF (SFLO ) may serve as a solution for investors looking to gain exposure to small caps while being mindful of FCF yields. Investors could potentially limit volatility and enhance returns by considering FCF.
SFLO tracks the Victory U.S. Small Cap Free Cash Flow Index (the Index), which screens companies for historical and projected FCF. The Index’s consideration of projected FCF sets SFLO apart from other FCF ETFs. This attribute allows the Index to target companies with high FCF yield and the highest growth rates.
After screening for historical and projected FCF, the Index then eliminates the slowest-growing companies to seek better outcomes in both growth and value markets.
The starting universe is the VettaFi US Equity Mid/Small-Cap 2500 Index. By starting with small- and mid-cap companies, the starting universe underpinning SFLO is larger than many other small-cap funds and can potentially offer more liquidity and a wider opportunity set.
Due to its larger opportunity set and consideration of companies’ future FCF, SFLO may be a compelling offering for investors looking to enhance their small-cap exposure.
1/ Source: Victory Capital Research; FactSet as of 6/30/2024
For more news, information, and analysis, visit the Free Cash Flow Channel
VettaFi LLC (“VettaFi”) is the index provider for SFLO, for which it receives an index licensing fee. However, SFLO 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 SFLO.
Disclosure Information
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. All investing involves risk, including the potential loss of principal.
All investing involves risk, including the potential loss of principal. Please note that the Fund is a new ETF with a limited history. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged 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 in smaller companies typically exhibit higher volatility. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions.
The fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. 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.
Additional Information
Investments in small-capitalization companies involve greater risks than those associated with larger, more established companies. Free Cash Flow Risk—Investing in companies with high free cash flows could lead to underperformance during periods when such investments are unpopular, and fluctuations in market conditions, industry disruptions, or company-specific factors may jeopardize the generation of free cash flow. Fund holdings and sector allocations are subject to change, may differ from the Index, and should not be considered investment advice.
The Victory U.S. Small Cap Free Cash Flow Index aims to select high quality companies from its starting universe by applying profitability screens. It then selects companies with the strongest free cash flow yield that exhibit higher growth. The Index is rebalanced and reconstituted quarterly. 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.
Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc., the Fund’s investment adviser.
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