In the 24-hour financial news cycle, the word “bubble” has been resurfacing due to frothy valuations in AI-focused big tech names. That said, investors need to become more familiar with another term: "free cash flow” (FCF). FCF may be able to help cut through the market noise surrounding valuations by providing investors with a sound fundamental metric—one that has the potential to mute the impact of downturns.
Last year, big tech names drove much of the stock market’s performance. It’s been raising questions among the investor community. That’s especially the case with companies spending heavily on AI, but that have yet to reap the rewards of their investments. VictoryShares and Solutions Client Portfolio Manager Michael Mack discussed the ramifications of Capex spending in a recent webinar: AI, Valuations, and Concentration Risks: Why Free Cash Flow Matters More Than Ever. As he noted, the byproduct of this spending won’t be seen immediately. But it could be spread out over 10 years. In turn, that may not bode well for future earnings.
“The more you spend, the more of a headwind it can be to your earnings growth going forward,” Mack noted.
The persistent disconnect between underlying earnings and stretched valuations may explain why we’re seeing increased caution around specific large-cap names. As an article in The Economist noted, buying a basket of stocks in the S&P 500 means paying 40 times more than the stocks’ underlying, cyclically adjusted earnings. Hence, the term “bubble” is starting to circulate once again. This is why some analysts are comparing the dot-com bubble from 25 years ago to what is happening in the stock market today.
So how can investors add a layer of protection to their portfolios by investing in companies that can potentially withstand a potential downturn? One answer: tilt their exposure to companies with strong FCF.
Why Free Cash Flow?
FCF is the remaining capital after subtracting capital expenditures from operating cash flow. Companies that are rich with excess FCF have the requisite capital that may help when hit in a financial storm. This may make companies with strong FCF metrics suitable candidates for consideration as an all-weather portfolio solution.
This makes the VictoryShares Free Cash Flow ETF (VFLO ) a fund that’s worthy of consideration. The ETF tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index), which focuses on a company’s expected FCF (a forward-looking measure of future cash flows), rather than solely on trailing cash flow figures. The result is a more targeted focus on a company’s potential to continue growing its cash flow operations.
VFLO’s portfolio of companies is full of high FCF that may be able to help with muting the effects of a growth-driven downturn and other market turbulence. This equity ETF can be used in tandem with a portfolio that’s already exposed to growth-fueled names in big tech or as a standalone, providing large cap value exposure.
For more news, information, and analysis, visit the Free Cash Flow Content Hub
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
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. The market prices of securities may go up or down, sometimes rapidly or unpredictably, due to general market conditions, such as real or perceived adverse economic, political, or regulatory conditions, recessions, inflation, or changes in interest or currency rates. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. ETFs may trade at a premium or discount to their net asset value. 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. Index Funds invest 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. 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 of cash, may adversely affect other shareholders, including potentially increasing capital gains. Investments concentrated in an industry or group of industries may face more risks and exhibit higher volatility than investments that are more broadly diversified over industries or sectors. Investments in companies in the energy sector may be subject to substantial government regulation, as well as risks involving changes in energy prices, international political instability, and liability for environmental damage and accidents resulting in loss of life or property. The profitability of companies in the healthcare sector may be affected by government regulations and healthcare programs, fluctuations in the cost of, and demand for, medical products and services and product liability claims. Derivatives may not work as intended and may result in losses. The Fund may frequently change its holdings, resulting in higher fees, lower returns, and more capital gains. The value of your investment is also subject to geopolitical risks such as wars, terrorism, trade disputes, 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.
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. You cannot invest directly in an index.
VictoryShares ETFs distributed by Victory Capital Services, Inc. (VCS). VCS is not affiliated with VettaFi.
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