Free Cash Flow: The Signal and Not the Noise

Investors are constantly barraged with event-driven headlines and market narratives that can influence their decisions. When looking to mute the market noise to identify companies with strong investment potential, investors can consider using free cash flow (FCF) as a signal. FCF is the remaining cash after subtracting expenses from operating cash flow.

Michael Mack, Client Portfolio Manager, and Lance Humphrey, Head of Portfolio Management—both representing VictoryShares and Solutions—joined TMX VettaFi Head of Research Todd Rosenbluth to discuss the mechanics of FCF in a recent webcast.

Seeking Value Through FCF

With artificial intelligence (AI) dominating the financial news headlines, the Magnificent Seven (Amazon, Alphabet, Apple, Meta, Microsoft, Nvidia, and Tesla) have recently received significant investor attention. In turn, this is leading to lofty valuations for other companies tied to the AI hype.

Additionally, Magnificent Seven companies are investing heavily to bolster their AI capabilities, leading to high capital expenditures (CapEx). As Mack identified during the webinar, heavy CapEx can reduce a company’s ability to generate free cash flow. CapEx may not show up immediately on an income statement, but FCF metrics reflect it, in Mack’s view.

“It’s important to follow where free cash flow is going,” said Mack, who introduced the VictoryShares Free Cash Flow ETF (VFLO) as a means to gain exposure to companies with strong FCF metrics.

VFLO’s Indexed Approach to Identifying Cash-Generating Companies

VFLO tracks the Victory U.S. Large Cap Free Cash Flow Index (“VFLO’s Index”). Inclusion hinges on a company’s forward- and trailing-FCF metrics. By screening for relatively undervalued companies with attractive growth prospects, Mack believes VFLO’s Index provides a more targeted focus on quality companies that have strong balance sheets.

Furthermore, VFLO may help investors to avoid “the value trap.” This refers to companies that may appear attractive based on their valuations but may not be growing FCF. This is where applying a growth filter helps mitigate this problem.

During the webcast, Mack and Humphrey explained how an FCF framework can be applied across investment styles. While VFLO’s Index uses free cash flow metrics to identify companies exhibiting valuation discipline and balance sheet strength, the same analytical lens can also be applied to growth-oriented companies. This provides Victory Capital a consistent approach for evaluating both value and growth characteristics through cash generation rather than earnings alone.

How GFLW’s Approach Applies Free Cash Flow to Growth Investing

Since 2020, index concentration and mega-cap dominance across broad-based benchmarks — including the S&P 500, Nasdaq-100, and Russell 1000 Growth — have reflected sustained investor preference for large-cap growth companies, a sentiment echoed in webcast survey results from the event. Humphrey identified common metrics that signal growth: sales, earnings, and long-term growth expectations. However, Humphrey noted that there’s an issue with the aforementioned metrics. They don’t account for profitability. He framed that FCF / Invested Capital is designed to solve this problem, and per the audience poll, it’s an important factor to consider.

Free Cash Flow divided by Invested Capital, also called free cash flow return on invested capital (FCF ROIC), measures how efficiently a company turns the capital invested in its business into spendable cash.

“We believe that free cash flow is a more effective measure at determining the health of a company,” said Humphrey, adding that when assessing profitable growth, it’s important to ask, “How much free cash flow does a company generate relative to what the company does in order to sustain their operation?”

Humphrey introduced the VictoryShares Free Cash Flow Growth ETF (GFLW), which tracks the Victory Free Cash Flow Growth Index (the “GFLW Index”). GFLW adds exposure to U.S. companies that exhibit high FCF profitability. Additionally, it adds the potential to compound FCF generation over time. The GFLW Index looks at 400 companies and narrows it down to 100 that are exhibiting strong FCF profitability with favorable growth prospects.

Furthermore, GFLW can be used in tandem with VFLO as complementary components in a portfolio. This allows investors to participate in the markets irrespective of whether value or growth is the dominant factor in the current market environment.

Whether investors want to tilt their factor exposure to value/growth with standalone exposure to VFLO/GFLW, or use both as complementary pieces, each solution seeks to pursue its investment objectives with the cost-effectiveness, flexibility and tax efficiency of the ETF investment vehicle.

For more news, information, and analysis, visit the Free Cash Flow Content Hub.

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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 Funds have 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. GFLW is a Fund is new with a limited operating history. As a result, it does not have a record of performance or other dealings for prospective investors to evaluate when making investment decisions. 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.  Index 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 respective Indexes. 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 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. Investments in companies in the industrials sector, including producers of durable goods and companies that process raw materials, may be adversely affected by changes in supply and demand for products and services, governmental regulation and changes in spending policies, world events and economic conditions. Derivatives may not work as intended and may result in losses. The Funds may frequently change their 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.

The Victory Free Cash Flow Growth Index focuses on high quality profitable companies that display a positive free cash flow trend. It selects larger cap companies with the highest free cash flow relative to invested capital that also exhibit higher growth.

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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VettaFi LLC (“VettaFi”) is the index provider for VFLO and GFLW, for which it receives an index licensing fee. However, VFLO and GFLW 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 GFLW.

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