VTV - VFLO: Free Cash Flow Focus More Value Than Growth An Alternative To COWZ

2023-12-07 12:43:59 ET

Summary

• Free cash flow factor underperformed in 2023, though the factor has rebounded over recent months as the stock market rally broadens out.
• The Victoryshares Free Cash Flow ETF offers a promising construct and impressive performance so far its in life, and I highlight why it has produced such strong returns.
• VFLO has a value tilt and low P/E ratio, and the ETF has outperformed the S&P 500 lately, though I don't see its growth screening as having much influence.

2023 draws to a close. Slow sessions in the stock and bond markets make for an opportune time to review how various equity factors have done in the year. Coming into 2023, many investors were focused on the one factor seen as offering some cushion to rising interest rates and dicey macroeconomic conditions: free cash flow.

Unfortunately, underperformance from a handful of key industries, namely those within the Energy sector, led to a weak last 12 months for this once-hot factor. Then, during the middle of the year, a new ETF was launched with a growth twist on a typical allocation focused on free cash flow.

I have a buy rating on the Victoryshares Free Cash Flow ETF (VFLO). I see the fund as having a promising construct but would like to see assets come into the strategy and more time get under its belt. Still, impressive performance and a modest growth-adjusted valuation are favorable characteristics.

High Cash Flow Factor Improving Lately, But Weak In 2023

According to the issuer , VFLO aims to provide large-cap value exposure with free cash flow yield and favorable growth prospects. Thus, it takes the common approach of spotting companies with strong trends in free cash flow and adds a growth filter to that. The issuer asserts that free cash flow is a crucial metric for assessing the value of a company, which I generally agree with, although some of the most lucrative early-stage investments can be in companies with low or even negative free cash flow. For background, free cash flow is the remaining cash a company has after covering all expenses - it can be used to invest in growing the business, paying dividends, or paying down debt, says Victoryshares.

VFLO is a small ETF with total assets under management of just $100 million, and it pays a small 0.5% trailing 12-month dividend yield, though VelocityShares shows a 2.0% dividend yield as of October 31, 2023. Share price momentum has been much better lately as the broad market has rebounded off its October low, and the fund recently notched a new high, impressively climbing above its summer peak.

Liquidity can be weak at times, though its 30-day median bid/ask spread is listed at just seven basis points as of December 6, 2023, and typical trading volume is exceptionally low at fewer than 20k shares daily. The ETF's not all that expensive with an annual expense ratio of 0.39%, but I noticed that there appears to be a 0.27% fee waiver right now which could expire at the end of October next year - a key risk for prospective investors to consider when looking ahead.

Digging into the portfolio, the Neutral-rated fund by Morningstar is primarily a large and mid-cap portfolio with a significant value tilt. Just 10% of VFLO is considered growth, so expect this ETF to outperform when economic improvements are seen since there is a high amount of cyclical exposure.

What's particularly appealing about the fund is that its price-to-earnings ratio is low at just 10.3 and long-term earnings growth of the current allocation is high near 18%, making for a PEG ratio well under 1. Interestingly, VFLO's growth screen does not translate into much traditional growth holdings, as evidenced by the style box below.

VFLO: Portfolio & Factor Profiles

It's important to consider the sector breakout of VFLO since it differs from the S&P 500 considerably. About one-third of the portfolio is in the Healthcare sector while just 12% is in the Information Technology space. Aside from Healthcare, Energy is another major overweight at 22.3%, about 18 percentage points greater than its weight in the SPX.

Impressively, the fund has held its own since oil peaked near $95 in late September. Furthermore, consider that the Healthcare ETF has been a lagging area of the market in that span, too. Clearly, the portfolio management process is off to a good start in what has been a weak period for the free cash flow factor, though growth has performed better.

VFLO Holdings & Dividend Information

Sector Returns Since Oil's Peak: XLE Worst, XLV Also Weak

The Technical Take

Performing technical analysis on such a new ETF is tough, and conclusions should be taken with a grain of salt. Still, notice in the chart below that VFLO rose sharply over the first few weeks of its life as stocks jumped to their YTD high by late July. The portfolio, like the rest of the market, went on to struggle in a correction through much of October. A steep recovery helped the fund climb above a key downtrend resistance line, and its 50-day moving average is now positively sloped with the ETF's price above that trendline indicator.

Volume has been very low over the last handful of months but take a look at the performance graph below the technical view - VFLO has beaten the SPDR S&P 500 ETF Trust (SPY) and has greatly outperformed the Vanguard Value Index Fund ETF Shares (VTV). I also included the Pacer US Cash Cows 100 ETF (COWZ) as VFLO is often compared to that popular fund - it has kept pace, and even topped the latest 3-month performance of COWZ. These are impressive signs early in the life of ETF.

VFLO: Hits New Highs In December

VFLO Paces With COWZ, Outperforms SPY Since Inception

The Bottom Line

I have a buy rating on VFLO. Its strategy requires some due diligence to grasp completely, but a somewhat low expense ratio, robust performance, and disciplined approach appear strong thus far.

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