Traditional value metrics like book value convey how much capital a company has invested in the business. But the sign of a truly profitable business is that it generates more free cash flow (FCF) than it needs.
FCF is the cash a business has left over after it has paid its capital expenditures. Historically, a company generating a lot of FCF has been a sign of a business with a sustainable competitive advantage.
See more: Why Price-To-Book Ratio Doesn’t Reflect a Company’s True Value
Sectors Generating the Most FCF
According to Michael Mack, Associate Portfolio Manager at VictoryShares and Solutions, the technology, consumer, and healthcare sectors have generated the most FCF over the past 30 years.
“These are sectors where the value of the business comes from intangible assets and intellectual property like an innovative patent or a strong customer brand,” Mack said.
Meanwhile, sectors like financials, energy, and utilities are commoditized. As Mack explained, those sectors have more of a level playing field, so it’s hard for companies to differentiate themselves. Therefore, they don’t tend to generate very much FCF.
“Oil is oil with little differentiation in who is drilling to get it,” Mack said. “Same with electricity or a loan from the bank.”
Targeting These Profitable Businesses With VFLO
Investors seeking profitable U.S. large-cap companies with high FCF yields should look into the VictoryShares Free Cash Flow ETF (VFLO ). The ETF seeks to track the performance of the Victory U.S. Large Cap Free Cash Flow Index (the Index). The Index calculates FCF yield by dividing expected FCF by enterprise value.
Expected FCF is the average of the trailing 12-month FCF and the next 12-month forward FCF. Enterprise value measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
The Index aims to select companies from a universe of U.S. large-cap stocks1 by applying a profitability screen. It then selects companies with the highest free cash flow yields that exhibit relatively higher growth potential based on trailing and forward-looking metrics.
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.
Disclosure Information
1/ The Victory U.S. Large Cap Free Cash Flow Index’s starting universe is the VettaFi 1000 Index which consists of market cap weighted U.S. large-cap stocks.
Enterprise value (EV) measures a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value includes in its calculation the market capitalization of a company but also short-term and long-term debt and any cash on the company’s balance sheet.
Book value is the sum of the amounts of all the line items in the shareholders’ equity section on a company’s balance sheet. You can also calculate book value by subtracting a business’s total liabilities from its total assets.
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