Free cash flow (FCF) ETFs that solely use backward-looking metrics missed out on AppLovin (APP), a stock that has grown tremendously during the past few months.
Shares of the tech company have surged during the fourth quarter of 2024, climbing nearly 650% year-to-date through November 18. AppLovin’s success highlights the importance of examining both forward expectations of FCF and backward-looking metrics.
See more: “VFLO’s Q3 Rebalance Brings Profitability Into Focus”
Investors should consider looking beyond the price-to-earnings (P/E) ratio to assess a stock’s potential and future profitability. The P/E ratio is a valuation metric that provides insight framed in a historical context and compares a company’s share price with its earnings per share. Victory Capital may have a solution for investors looking for unique exposure to companies generating healthy FCF.
The VictoryShares Free Cash Flow ETF (VFLO) tracks the Victory U.S. Large Cap Free Cash Flow Index (the Index) which considers future FCF in addition to trailing FCF. AppLovin screened into the Index during the most recent quarterly rebalance due to the Index’s consideration of forward-looking metrics.
How VFLO’s Approach Identified AppLovin
According to Michael Mack, associate portfolio manager for VictoryShares and Solutions, the Index tends to screen for securities that generate a FCF yield of around 5.5%. AppLovin’s FCF yield was 5% on a historical basis, but the forward-looking yield was 7% due to the company’s efforts to grow cash flows. Mack said this forward-looking metric made the company eligible for inclusion in VFLO.
AppLovin is experiencing rapid growth as its AI gets smarter, driving better results for customers. The company reported third-quarter results on November 6, showing FCF was $545 million, up 182% year-over-year.
During a fireside chat, AppLovin’s CEO shared with investors that he had difficulty selling his idea to venture capitalists early on. With this, he began to run AppLovin from the start to maximize FCF—not grow revenue.
“It is a great example of how a forward-looking approach is a more favorable lens to view growth stocks,” Mack explained. “If you consider a company that is growing, they’re going to look better on their forward-looking numbers than they will on their historical. Occasionally, you get growth stocks that are trading at a high FCF yield, and one should lean into that opportunity.”
AppLovin is a compelling case study as to why investors should assess trailing and future FCF. By assessing the stock’s future potential, investors might have anticipated its strong growth.
As of 9/30/2024, VFLO held a 1.87% weight position in AppLovin Corp. Class A (APP).
For more news, information, and analysis, visit the Free Cash Flow Channel.
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. VettaFi has no obligation or liability concerning 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.
All investing involves risk, including the potential loss of principal. Please note that the Fund is a new ETF with a limited history. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The ETF invests 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. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions The ETF could also be affected by company-specific factors that could jeopardize the generation of free cash flow. 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. Derivatives may not work as intended and may result in losses.
Additional Information
If a seed investor redeems its shares, it could negatively impact the Funds’ NAV, market price and brokerage costs. The ETF has the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited, and commissions are often charged on each trade. ETFs may trade at a premium or discount to their net asset value. The ETF invests in securities included in, or representative of securities included in, the Index, regardless of their investment merits.
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, 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, 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.
Distributed by Foreside Fund Services, LLC (Foreside). Foreside is not affiliated with Victory Capital Management Inc. (VCM), the Fund’s advisor. Neither Foreside nor VCM are affiliated with VettaFi.
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