Recent research from Pacer ETFs and FTSE Russell shows that the 100 largest companies in the US large-cap Russell 1000® Index with the highest free cash flow yields (free cash flow / enterprise value) have produced a higher return than the 100 largest Russell 1000 companies leading in other valuation metrics (detailed below) over the last 28 years through December 8, 2016.
Free cash flow yield is the cash remaining on a company’s balance sheet after it has paid expenses, interest and taxes and has made any long-term investments. Free cash flow is often used by market participants as one of the key ways to gauge a company’s long-term health.
Sean O’Hara, President of Pacer ETF Distributors:
“High quality, high free-cash flow generating companies can be an important part of a well-balanced portfolio because of their ability to sustain and grow income while also providing an opportunity for capital appreciation over time. This reliability can be particularly important during this time of heightened market volatility and change.”
The following chart plots the overall return and the percentage of negative 12 return periods for the Russell 1000 largest 100 companies for a variety of valuation metrics as well as the benchmark Russell 1000 from December 31, 1988 to December 8, 2016. The free cash flow to enterprise value (FCF/EV) measure sits in the top left corner with the mix of highest positive annualized return and lowest percentage of negative 12 month returns.
And for a shorter time period, the top 100 companies in the Russell 1000® Index for free cash flow over enterprise value have outperformed the Russell 1000 Index for the year-to-date (+12.2%), fourth quarter-to-date (+7.5%) and since the US presidential election (+8.3%).
Tom Goodwin, Senior Index Research Director, FTSE Russell:
“Market indexes have grown more sophisticated in recent years, allowing market participants to sort and weight stocks by a number of criteria including key stock-specific characteristics such as free cash flow. These tools can help market participants look at very specific factors to complement the exposure gained through a broad market capitalization weighted index.“
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