Free Cash Flow: Quality in a High-CapEx Environment

In a recent webcast, two Victory Capital portfolio managers explained why FCF matters now and how FCF-driven strategies can navigate the market’s twin headwinds of extreme concentration and rising CapEx.

A primary takeaway for allocators is the growing disconnect between reported earnings and actual cash availability. Because capital expenditures — the money a company spends on long-term physical assets — hit FCF immediately and in full but reach earnings only gradually via depreciation (the accounting practice of spreading an asset’s cost across its useful life, rather than recording it all at once), the two measures can tell very different stories during a CapEx boom. Michael Mack, Client Portfolio Manager, noted that while earnings and FCF historically moved in tandem for the Magnificent Seven (Mag 7)1, they have recently deviated due to a “massive CapEx spend.”

Mack explained that looking solely at earnings during a CapEx boom risks the lagged effect of depreciation. Because companies typically depreciate capital assets over five to six years, only 15% to 20% of a given year’s CapEx flows through to that year’s earnings via depreciation. FCF, by contrast, reflects the full cash outlay in the period it occurs.

That divergence is now showing up in valuations. Mack pointed out that Mag7 companies like Amazon and Tesla have seen cash flows turn negative, while others have seen FCF multiples “go parabolic” as shrinking cash flow inflates the price-to-FCF ratio even without a change in share price. For context, the price-to-FCF ratio is the share price divided by FCF per share.

Lance Humphrey, CFA®, Head of Portfolio Management, and Mack argued that traditional value indexes are “structurally challenged.” Those indexes lean on metrics like price-to-book, which can fail to capture intangible assets in an increasingly asset-light economy. Price-to-Book is the ratio of a stock’s market value (price) to the value of total assets less total liabilities (book value).

The VictoryShares Free Cash Flow ETF (VFLO) tracks an Index that addresses this through a two-part screen, and it uses enterprise value rather than market capitalization as the FCF yield denominator, a deliberate choice that accounts for debt and rewards stronger balance sheets:

• The Forward Look: Unlike strategies that focus on trailing data alone, VFLO’s Index calculates expected FCF as the average of a company’s trailing 12-month FCF and the next 12-month consensus forward estimate. Mack noted that the forward-looking blend is designed to avoid value traps where a company looks cheap only because past results were strong.
• The Growth Filter: After selecting the top 75 companies with the highest FCF yield, the Index applying a growth filter to select the 50 stocks with the highest growth scores. Mack noted that this growth filter allows the approach to maintain attractive valuations while targeting companies with significantly higher growth rates.

Addressing risk, Humphrey highlighted that in a study of the S&P 500’s five worst months since VFLO inception (6/21/2023), VFLO “fared better in those drawdown months compared to the major indexes.”2 The strategy focuses on companies with strong balance sheets that can deploy excess cash for shareholder-friendly actions, such as buybacks, even when sentiment turns negative.

For more news, information, and analysis, visit the Free Cash Flow Content Hub

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, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO.

Disclosure Information

1/ The Magnificent Seven (Mag 7) consists of Alphabet (GOOGL; GOOG), Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), NVIDIA (NVDA), and Tesla (TSLA). Not to be construed as a recommendation to buy or sell individual securities. As of 6/30/2026 VFLO held 0% of the Mag 7.
2/ This analysis identifies the 5 months with the worst S&P 500 Index returns since VFLO’s Inception and shows the average total return across those periods.

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. The Fund has the same risks as the underlying securities traded on the exchange throughout the day. ETFs may trade at a premium or discount to their net asset value. The market prices of securities may go up or down, sometimes rapidly or unpredictably, due to general market conditions, such as real or perceived adverse economic, political, or regulatory conditions, recessions, inflation, or changes in interest or currency rates. Investing in companies with high free cash flows could lead to underperformance when such investments are unpopular or during periods of industry disruptions. The Fund could also be affected by company-specific factors that could jeopardize the generation of free cash flow. Index Funds invest 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. 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 of cash, may adversely affect other shareholders, including potentially increasing capital gains. 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. Investments in companies in the energy sector may be subject to substantial government regulation, as well as risks involving changes in energy prices, international political instability, and liability for environmental damage and accidents resulting in loss of life or property. The profitability of companies in the healthcare sector may be affected by government regulations and healthcare programs, fluctuations in the cost of, and demand for, medical products and services and product liability claims. Derivatives may not work as intended and may result in losses. The Fund may frequently change its holdings, resulting in higher fees, lower returns, and more capital gains. The value of your investment is also subject to geopolitical risks such as wars, terrorism, trade disputes, 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.

Distributed by Victory Capital Services, Inc. (VCS). VCS is not affiliated with VettaFi.

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