The VictoryShares Free Cash Flow ETF (NASDAQ:VFLO), a new free-cash-flow-focused ETF from VictoryShares, is off to a promising start with a gain of 26% since launching last June. I’m bullish on VFLO for the long term based on its sound strategy of focusing on free cash flow yield, its stringent investment process, and strong performance out of the gate.
What Is the VFLO ETF’s Strategy?
VFLO launched on June 20, 2023, and now has $378.4 million in assets under management (AUM). According to fund sponsor VictoryShares, VFLO “seeks to offer exposure to high-quality, large-cap U.S. stocks that trade at a discount and have favorable growth prospects.”
The fund focuses on free cash flow yield in order to identify these stocks and employs a rigorous investment process to select its holdings, which we’ll discuss below.
Why Focus on Free Cash Flow?
Free cash flow is the cash that a company has left over after paying for expenses, interest, taxes, and long-term investments. This cash can then be put to work to create value for shareholders by buying back shares, paying dividends, or making acquisitions.
Free cash flow yield is then derived by taking a company’s free cash flow per share and dividing it by its share price. The higher the free cash flow yield is, the more attractive the stock looks on this basis.
This is a useful metric because companies that turn a large amount of their revenue into free cash flow are likely operating efficiently and firing on all cylinders. Furthermore, many astute investors favor free cash flow over net income because net income can be affected by non-cash items and accounting adjustments, while free cash flow paints a clearer picture of the actual cash available for reinvestment or returns to shareholders.
For example, legendary investor Joel Greenblatt explains that while stocks with high free cash flow yield may be valued cheaply because of concerns or challenges, he tends to prefer these companies with lots of free cash flow and good returns on capital because it means they are deploying their capital effectively. He feels that focusing on these types of businesses helps him to avoid “value traps.”
Other renowned investors like Warren Buffett and Charlie Munger have also been known to place a strong emphasis on free cash flow or metrics that align closely with it (for example, Buffett’s concept of “owner earnings”).
Stringent Investment Process
VFLO starts with an investment universe of 400 of the largest profitable U.S. companies. It then selects the 75 stocks from this list with the highest free cash flow yields.
It’s important to note that VFLO looks at both trailing free cash flow as well as forward-looking free cash flow estimates in order to “provide a better estimate of a company’s expected future free cash flow.” VFLO believes that this is “an improved approach to evaluating free cash flow.”
Next, VFLO takes these 75 stocks and narrows them down to the 50 with the highest growth scores (a metric that includes sales trend, EBITDA growth, and long-term earnings growth) to eliminate stocks with high free cash flow yields but poor growth prospects. Lastly, these remaining 50 stocks are weighted based on the size and yield of their free cash flow.
This extensive screening process leaves the fund with a group of approximately 50 stocks that generate ample free cash flow, indicating sound financial health.
So, what does a portfolio of stocks that make it through this rigorous screening process look like?
VFLO’s Holdings
VFLO currently holds 49 stocks, and its top 10 holdings account for a reasonable 34.1% of the fund’s assets. Below, you’ll find an overview of VFLO’s top 10 holdings using TipRanks’ holdings tool.
The fund’s top holding, energy giant ExxonMobil (NYSE:XOM), makes up 5.0% of assets, so there is very little concentration risk here.
Several of VFLO’s top holdings, including ExxonMobil, NRG Energy (NYSE:NRG), Chevron (NYSE:CVX), and Vistra Energy (NYSE:VST), hail from the energy sector, which is unsurprising, as these energy stocks are generating a lot of free cash flow right now. Energy is indeed the sector that the fund has the largest exposure to, with a weighting of 25.5%.
But other sectors are represented as well through the likes of semiconductor company Qualcomm (NASDAQ:QCOM), homebuilder Lennar (NYSE:LEN), and healthcare stocks like Cigna (NYSE:CI), Elevance Health (NYSE:ELV), and CVS Health (NYSE:CVS). Healthcare is the fund’s second-largest exposure, with a weighting of 24.4%.
VFLO’s holdings also feature some impressive Smart Scores. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks a score from 1 to 10 based on eight market key factors. A score of 8 or above is equivalent to an Outperform rating. Seven of VFLO’s top 10 holdings feature Outperform-equivalent Smart Scores of 8 or higher, including NRG Energy, Vistra Energy, and Qualcomm, which feature “Perfect 10” Smart Scores.
Early Signs Look Promising
As a fairly new fund, VFLO doesn’t have much of a long-term track record yet, but it is up an impressive 26% since launching last June. The fund will certainly need to prove itself over time to gain more traction with investors, but it’s off to a good start.
It’s worth noting that while there are differences between them, other ETFs that focus on free cash flow, such as the Pacer US Cash Cows 100 ETF (BATS:COWZ), which I am also a proponent of, have generated strong results over time. To be clear, VFLO is not COWZ, but this style of investing can be very effective.
What Is VFLO’s Expense Ratio
VFLO charges an expense ratio of 0.39%, meaning that an investor putting $10,000 into the fund will pay $39 in fees annually. While this isn’t as cost-effective as the fees for some of the major index funds out there, it is a reasonable expense ratio and is below the historical average expense ratio for all ETFs (0.57%). If the ETF continues to perform well, this expense ratio will be easy to stomach, but if it underperforms, then it won’t be worth it.
Is VFLO Stock a Buy, According to Analysts?
Turning to Wall Street, VFLO earns a Moderate Buy consensus rating based on 39 Buys, 11 Holds, and zero Sell ratings assigned in the past three months. The average VFLO stock price target of $35.65 implies 14.9% upside potential.
The Takeaway: Go with the Flow
In conclusion, VFLO is enjoying a strong start to its life and looks like an attractive ETF for the long term. I’m bullish on VFLO based on its strong performance right out of the gate and its sound strategy of focusing on free cash flow and free cash flow yield. Additionally, it has a carefully selected portfolio of high-free-cash-flow-yielding stocks that make it through an extensive screening process and enjoy strong TipRanks Smart Scores.
The track records of other ETFs that focus on free cash flow, like COWZ, are also reason for optimism.
