Rethinking Stock Selection: Why Expected Free Cash Flow Yield Matters More Than Earnings

The Limitation of Traditional Growth Metrics

When evaluating investment opportunities, many professionals rely on conventional indicators like earnings growth or revenue expansion to gauge whether a company is delivering value. Yet these time-tested metrics frequently miss the mark when it comes to identifying truly promising investment candidates.

According to Michael Mack, Portfolio Manager at VictoryShares, there’s a compelling pattern worth noting: “Many of today’s surging growth stocks were previously undervalued equities that boasted exceptional free cash flow yields.” This observation challenges the conventional wisdom that popularity and market sentiment accurately reflect a company’s potential. “The market frequently underestimates how effectively companies can transform their business models and tap into emerging growth opportunities,” Mack points out.

Beyond the Numbers: Understanding Cash Generation

The challenge with relying solely on earnings data is that accounting methods can obscure the true financial picture. Free cash flow (FCF), by contrast, represents the actual cash a company generates after accounting for capital requirements—cash that can be distributed to shareholders, applied toward debt reduction, or reinvested to fuel expansion.

Expected free cash flow yield offers a more transparent lens for evaluating corporate value compared to conventional metrics. This measure combines trailing 12-month FCF with forward-looking 12-month projections, then divides this average by enterprise value—a calculation that reveals a company’s genuine cash-generation capacity relative to its market valuation.

A robust FCF yield signals more than just strong profitability. It indicates a company generates meaningful cash relative to what the market values it at. This metric illuminates financial resilience, operational flexibility, and capacity for long-term value creation. Whether through reinvestment in growth initiatives, weathering economic challenges, or returning capital via dividends and share repurchases, a healthy FCF yield demonstrates the resources available to management.

Finding Hidden Growth Opportunities

The VFLO ETF (VictoryShares Free Cash Flow ETF) applies this principle systematically. The fund targets profitable U.S. large-cap companies demonstrating elevated free cash flow yields and aims to mirror the Victory U.S. Large Cap Free Cash Flow Index.

The Index’s screening process starts by isolating companies from the broader U.S. large-cap universe that meet profitability thresholds. From there, it selects the highest FCF yield generators while filtering for those displaying compelling growth prospects based on both historical performance and forward estimates.

Enterprise value—encompassing market capitalization plus total debt minus cash reserves—serves as the denominator in this yield calculation, offering a more holistic view of what investors actually pay for a company’s earning power than market cap alone.

Mack emphasizes an important takeaway: “Growth leaders don’t always emerge from today’s trendy sectors. Many overlooked companies trading at attractive free cash flow yields today could become the growth powerhouses of tomorrow. Chasing the latest market darlings isn’t the only path to capturing tomorrow’s winners.”

Key Considerations for Investors

Before committing capital, carefully evaluate an ETF’s objectives, costs, and risk factors. As with all investments, principal is at risk, and past performance doesn’t guarantee future results. VFLO, as a newer fund, carries typical ETF risks including intraday trading volatility, potential premium/discount pricing relative to net asset value, and the reality that fund performance may diverge from its underlying index.

Concentration risk applies particularly when holdings cluster within specific industries. Additionally, holdings may experience higher volatility, and geopolitical uncertainties—from conflict to pandemic—can influence outcomes alongside technology disruptions.

Understanding how expected free cash flow yield distinguishes genuine value from temporary market mispricing equips investors to look beyond consensus narratives and identify durable growth opportunities.