Why Free Cash Flow Could Be the Antidote to High Rates

Originally published on May 21, 2024

Markets remain highly responsive to economic data as concerns around Fed policy and high interest rates dominate the second quarter so far. Increasing bond yields due to high or rising interest rates have historically put pressure on equity markets, so investors looking for opportunity in this type of environment may do well to consider free cash flow strategies.

Free cash flow (FCF) is the remaining cash a company has after covering all expenses. It can be used to invest in growing the business, pay dividends or pay down debt.

The team at VictoryShares has developed an FCF methodology which measures FCF yield holistically by including a company’s trailing as well as anticipated FCF. In addition to this measure of FCF, the methodology applies a growth filter based on earnings. The inclusion of future FCF and earnings allows the strategy to offer forward-looking exposure to high-quality companies, trading at a discount with favorable growth prospects.

“Free cash flow is the cash left over after a company has paid its expenses, taxes, interest, and reinvested in the business,” Michael Mack, associate portfolio manager for VictoryShares and Solutions stated. “The higher rates are already reflected in FCF's calculation that includes all of a company's debt in the current rate environment, so the companies that are generating cash flows may be more likely to withstand higher interest rates.”