A number of large-cap companies have posted lackluster earnings after dealing with inflation, supply-chain issues, and broad economic uncertainty. Added to that, “the strong U.S. dollar emerged as a significant negative earnings factor that weighed on the profitability of all companies with big international operations,” wrote Sheraz Mian for Zacks.
Earnings don’t always tell the whole story. In fact, sometimes the tale they tell isn’t just incomplete, but also inaccurate.
Bob Shea, CEO and CIO of FCF Advisors, told VettaFi that his firm believes that “GAAP earnings have significant disadvantages,” and “accounting practices allow a lot of leeway and discretion to management.” Meanwhile, “the ability to manipulate and distort free cash flow is a lot more difficult than with earnings.”
Amid sustained market volatility and high inflation, combined with an anticipated recession, a lot of large companies and banks have been shoring up on free cash flow. 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.
FCF Advisors specializes in free cash flow investment strategies, primarily through its Free Cash Flow Quality Model. They have been focused on this factor since 2011 and are specialized in multi-factor fundamental analysis grounded in decades of research.
TTAC aims to outperform the Russell 3000 through a fundamentals-driven investment process that selects an average of 144 stocks based on free cash flow strength. Its holdings are then weighted by a modified market-cap log transformation, allowing increased exposure to companies with the strongest proprietary free cash flow rankings.
TTAI, meanwhile, aims to outperform the MSCI All Country World Index excluding the U.S. through an active investment process. A quant model is used to rank stocks based on proprietary measures of free cash flow. Roughly 140 of the highest-ranked stocks are selected and then weighted on a modified market-cap basis.
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.
“Free cash flow is so important right now, given that the allocation environment has gotten exponentially more difficult in 2022,” Shea said. “Cohorts have never seen an environment like this. In a difficult environment, people want to make sure they understand what they own.”