Value investing remains a core component within many investors’ portfolios. However, traditional value indexes may miss opportunities within the category because of how they define and screen for value.
Value investing is a deeply established style of investing that was first developed over a century ago at Columbia Business School. For an investment strategy with such a long history, it may be surprising for investors to learn that value today is defined and measured in a wide range of ways.
These different value investing methodologies may result in notably different return profiles and portfolio constituents. Michael Mack, Associate Portfolio Manager at VictoryShares and Solutions, discussed free cash flow (FCF) and value investing in an August 2024 webcast hosted on the VettaFi platform. Mack explained that when constructing indexes, there often is a preference for traditional, large, well-established data sets and metrics.
Within value investing, this sometimes translates into using price-to-sales or price-to-book data to define value stocks. These types of traditional measurements are well documented, with a long history of recorded data to support various methodologies utilizing them. However, they may not capture the full picture of a company. For example, price-to-book measures a company’s stock price divided by its book value or total assets minus liabilities. However, this fails to consider a company’s intangible assets, which may drive potential future growth.
A metric used less often within value indexes is FCF. FCF is the remaining cash a company has after covering all expenses. A company may use this money to grow its business, pay dividends, or pay down debts. It’s one method of measuring a company’s financial health and defining its value.
Quality and Value with a Growth Tilt
VictoryShares takes this one step further using a methodology that considers FCF yield and measures both trailing as well as expected FCF. FCF yield considers a company’s enterprise value or total value, including debt. It’s calculated by dividing the cash left over after paying capital and operating expenses by the enterprise value.
By utilizing forward-looking FCF estimates, the approach may provide a more comprehensive snapshot of a company’s FCF and value. The methodology then adds a growth filter to the companies with the highest FCF yield while also filtering for earnings and sales trends. This creates a portfolio of quality value companies that may differ from more traditional value indexes.
VictoryShares offers two ETFs that provide investors access to quality companies with high FCF yields — the VictoryShares Free Cash Flow ETF (VFLO ) and the VictoryShares Small Cap Free Cash Flow ETF (SFLO ).
Their underlying indexes use a rules-based methodology to account for overall FCF and FCF yield. VFLO tracks the Victory U.S. Large Cap Free Cash Flow Index, while SFLO tracks the Victory U.S. Small Cap Free Cash Flow Index.
VFLO has a net expense ratio of 0.39% (gross expense ratio of 0.66%), while SFLO carries a net expense ratio of 0.49% (gross expense ratio of 0.76%).
SFLO’s net expense ratio reflects the contractual waiver and/or reimbursement of management fees through December 31, 2024.
VFLO’s net expense ratio reflects the contractual waiver and/or reimbursement of management fees through October 31, 2024.
For more news, information, and analysis, visit the Free Cash Flow Channel
VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO, for which it receives an index licensing fee. However, VFLO and SFLO are 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 and 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. Please note that the Funds are new ETFs with a limited history. The Funds have 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 Funds invest in securities included in, or representative of securities included in, the Index, regardless of their investment merits. The performance of the Funds may diverge from that of their Indexes. 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 Funds 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 Funds’ shares. The actions of large shareholders, including large inflows or outflows, may adversely affect other shareholders, including potentially increasing capital gains. 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
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.
The Victory U.S. Large 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. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.
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