The Federal Reserve’s aggressive plan to fight inflation has many investors worried that a recession is nigh. As a result, undervalued stocks with high free cash flows have been gaining in popularity with investors.
Free cash flow represents the cash a company has available to use on repaying creditors or sending dividends to investors.
“Given the market volatility in 2022, advisors have sought out companies with strong free cash flow generation as they provide relative stability,” said Todd Rosenbluth, head of research at VettaFi.
ETFs such as the FCF US Quality ETF (TTAC) and the FCF International Quality ETF (TTAI) both invest in companies that have strong free cash flow characteristics, as those companies tend to be well-positioned to weather economic storms and survive rough markets. Both funds are actively managed.
TTAC aims to outperform the Russell 3000 through a fundamentals-driven investment process that selects about 150 stocks based on free cash flow strength, according to its FactSet Analyst Report. Its holdings are then weighted by a modified market-cap log transformation, which allows for increased exposure to companies with the strongest proprietary free cash flow rankings.
After that, the portfolio will be rated with an ESG score, excluding companies with low ESG ratings. Firms with an extreme rise in shares count and increase in leverage are excluded.
TTAI, meanwhile, aims to outperform the MSCI All Country World Index ex USA through an active investment process. A quant model is used to rank stocks based on proprietary measures of free cash flow. Highly leveraged firms, that incur debt to buy back shares, or don’t satisfy ESG criteria, are screened out. Roughly 150 of the highest-ranked stocks are selected and then weighted on a modified market-cap basis that factors in free cash flow and log transformation.
Rosenbluth added that “advisors have turned to actively managed strategies in 2022 to benefit from the flexible approaches they offer. These funds take a fundamental approach to identify high-quality companies trading at attractive levels.”
For more news, information, and strategy, visit the Free Cash Flow Channel.