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Index IDEA: Free cash flow yield a driver of long-term performance for US large-cap stocks

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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Views expressed by Tom Goodwin  of FTSE Russell and Sean O’Hara of Pacer ETFs are as of December 22nd and subject to change. These views do not necessarily reflect the opinion of FTSE Russell or the LSE Group.

No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the Russell Microcap® Index or the fitness or suitability of the indexes for any particular purpose to which they might be put.

No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this IDEA should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group index data and the use of their data to create financial products require a licence from FTSE, Russell, FTSE TMX, MTSNext and/or their respective licensors.

Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets.

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