The Critical Role of Free Cash Flow in Today’s Market

With the S&P 500 Index pushing to new highs, many advisors are confronting a familiar challenge: how to maintain equity exposure without taking on unnecessary valuation risk. In a recent webcast, AI, Valuations, and Concentration Risks: Why Free Cash Flow Matters More Than Ever, Victory Capital client portfolio manager Michael Mack made the case for why free cash flow (FCF) has become one of the most effective tools for identifying durable, high-quality opportunities in today’s market.

During the discussion with TMX VettaFi Head of Sector & Industry Research Roxanna Islam, Mack highlighted how FCF can help advisors cut through headline noise—especially in an environment defined by elevated valuations, concentration in mega-cap growth names, and rising AI-related capital spending. He emphasized that focusing on companies with strong and sustainable cash generation can enhance portfolio resiliency and position clients for long-term growth.

FCF’s Influence on Growth

The start of the webinar highlighted a historical account on the dominance of growth and value, which tends to come in cycles. Attendees were asked how they allocated to both factors, which resulted in a relatively balanced outcome — 23% towards growth and 15% to value in today’s market.

“I congratulate our audience on having a healthy growth allocation because that’s been beneficial over time,” Mack said upon seeing the results, mentioning that the resilience of growth over time can be attributed to FCF generation. This has historically been a key driver for growth’s performance compared to value.

Mack noted that AI-related spending has been driving a decline in FCF even as earnings rise. He added that this is because capital expenditures reduce FCF immediately, while their impact on earnings is deferred.

“The longer these companies spend, the more they’re going to be paying for it in earnings going forward,” Mack said. He confirmed the importance of focusing on FCF to maximize growth opportunities. He also emphasized the need to broaden exposure beyond the Magnificent Seven companies — Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia, (NVDA), Meta Platforms (META), and Tesla (TSLA) — propelling the market performance this year.

The Mechanics of FCF

Next, Mack delved into the mechanics of evaluating FCF. The VictoryShares FCF suite of ETFs track indexes that primarily focus on Expected FCF, a combination of Trailing FCF as well as Forward FCF. The latter is an important gauge to measure a company’s future profitability.

As Mack described, the approach involves looking at a company’s cash flow relative to its enterprise value. Ultimately, the goal is to find companies that are trading at attractive valuations relative to their profitability.

Furthermore, Mack stressed the importance of looking at FCF yield and FCF return on invested capital (ROIC). ROIC, in particular, provides a “more comprehensive measure of a company’s profitability,” he said.

FCF ETF Options

As mentioned, the FCF metric is applicable to Victory’s suite of ETFs. Mack did a rundown on the various funds offered and the strategies they employ:

All of the aforementioned funds underwent reconstitutions and rebalances in September. Those rebalances should help the ETFs capture upside in companies exhibiting strong FCF characteristics.

FCF Flexibility

Mack also addressed economic slowdowns and concentration risk as top-of-mind concerns using a FCF strategy. During times of market distress, companies with substantial cash cushions have the requisite capital to withstand downturns as opposed to those that are heavily invested. All in all, it supports the case for using a FCF strategy in any market environment, potentially making FCF ETFs a flexible, all-weather solution.

“Diversify your portfolios and take a free cash flow approach,” Mack said.

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

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

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Disclosure Information

Diversification does not assure a profit or protect against loss.

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 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. The Funds are new with a limited operating history. As a result, the funds do not have a record of performance or other dealings for prospective investors to evaluate when making investment decisions.  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. 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. International investments can be more volatile than the U.S. market due to increased risks of adverse issuer, political, regulatory, market, or economic developments and can perform differently from U.S. investments.  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. 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

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.

VictoryShares ETFs distributed by Victory Capital Services, Inc. (VCS). VCS is not affiliated with VettaFi.

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