June 13, 2024 By: Chris Liu |
| Fund in focus: Brompton U.S. Cash Flow Kings ETF (KNGU) and Brompton Canadian Cash Flow Kings ETF (KNGC). |
IntroductionAs of March 2024, equity valuations, particularly in the U.S., have reached elevated levels.1 We believe this reflects investor optimism regarding an economic “soft landing”, excitement surrounding AI technology and expectations of central bank interest rate cuts prior to year-end. However, any deviation from these expectations could lead to increased equity market volatility. At the same time, corporate earnings reman strong2 and U.S. investors have $6 trillion3 of cash sitting on the sidelines, implying support for equity prices. Opting not to invest in equities in the current market presents its own risk of potentially missing out on positive equity returns. Given these uncertainties, investing in high-quality companies with financial strength and flexibility is more important than ever. We believe that focusing on equities with robust free cash flow generation ability is particularly important in the current environment. Free Cash Flow (FCF) represents the excess cash after a company pays its operating expenses and capital expenditures.
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5 Reasons to Consider High Free Cash Flow StocksCompanies with strong and growing free cash flow are well-positioned to outperform for several key reasons: 1) Free Cash Flow Offers Resilience in Uncertain MarketsStrong cash flow provides a financial cushion that allows companies to continue operating and investing even when revenues decline during economic downturns or industry slumps. This cash buffer can help companies survive periods of low demand or profitability without having to take on excessive debt. Companies that generate strong free cash flow often have competitive advantages such as well-known brand names, cost-efficient manufacturing processes, or high barriers to entry in their industry, which can help them maintain leadership through various market environments. 2) Companies with High Free Cash Flow are Less Reliant on DebtIn today’s environment of high interest rates and high borrowing costs, strong cash flow is particularly important. Companies generating robust internal cash flows are less reliant on debt markets to fund operations, investments, and growth initiatives. Surplus cash reserves provide flexibility to maintain operations, service and pay down debt obligations, and pursue growth opportunities when companies with lower free cash flow may be constrained. 3) High Free Cash Flow Companies Have the Ability to Increase Shareholder ValueCompanies with high free cash flow generate excess cash that can be used to reinvest in the business and make strategic acquisitions. Additionally, excess cash can be used to return capital to shareholders by initiating or increasing dividends or buying back shares. All of these initiatives can benefit shareholders by enhancing a company’s stock price. 4) Free Cash Flow Yield: An Important Valuation MetricFree Cash Flow Yield measures a company’s Free Cash Flow relative to its enterprise value, providing a way to identify companies generating attractive levels of Free Cash Flow that may be undervalued. Free Cash Flow Yield is considered a more reliable valuation metric than the commonly recognized price-to-earnings (P/E) and price-to-book (P/B) ratios. P/E is based on earnings, which can be affected by accounting estimates, and P/B focuses on the book value of assets, which is often far less than the replacement values of those assets. Additionally, both P/E and P/B are difficult to compare across sectors with different margins, capital structures, and levels of intangible assets. |
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5) High Free Cash Flow Yield: History of OutperformanceCompanies with high free cash flow yields have historically outperformed the broader equity market. The Brompton Index One U.S. Cash Flow Kings Index tracks the performance of mid-to-large-capitalization U.S. equities whose issuers exhibit high free cash flow relative to their enterprise value. The Brompton Index One U.S. Cash Flow Kings Index has consistently outperformed the S&P 500 Index, as show in the chart below. |
Annualized Total Return Comparison |
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Brompton’s ApproachBrompton U.S. Cash Flow Kings ETF (KNGU) and Brompton Canadian Cash Flow Kings ETF (KNGC) are unique rules-based ETFs in Canada designed to invest in high quality companies with high free cash flow generating abilities relative to their overall enterprise value. Companies that generate high levels of free cash flow tend to be well-established, financially stable, and have a competitive advantage in their respective industries. |
Chris Liu
Vice President, ETFs
Chris Liu has over a decade of experience in the investment industry and has held several senior roles at BMO and HSBC in the areas of investment product management and fund analytics. Mr. Liu is a CFA Charterholder and received his Honours Bachelor’s degree in Economics from the University of Toronto. He also holds Chartered Investment Manager (CIM®) and Responsible Investment Specialist (RIS) designations.
| 1Source: Morningstar, “Is the US Stock Market Expensive Right Now?”
2Source: Morningstar, “2024 Q1 Earnings Insight” 3Source: Bloomberg, “Money-Fund Assets Rise to $6 Trillion for First Time in 3 Weeks” Past performance of the Brompton Index One U.S. Cash Flow Kings Index (the “Index”) does not necessarily indicate how the ETF will perform in the future. Further information about the Index is available from the Index provider on its website at www.indexone.io. The historical performance of the Index is hypothetical performance and should not be considered as a tradable portfolio and does not guarantee any future performance of the strategy. The Index is not investment advice and should not be construed as investment advice. The Index relies directly or indirectly on various sources of information to assess the criteria of issuers included in the Index, including information that may be based on assumptions and estimates. Neither the ETFs, the Index provider, or Brompton Funds Limited (“BFL”) can offer assurances that the Index calculation methodology or sources of information will provide an accurate assessment of included issuers or a correct valuation of securities, nor can they guarantee the availability or timeliness of the production of the Index. This document is for information purposes only and does not constitute an offer to sell or a solicitation to buy the securities referred to herein. The opinions contained in this report are solely those of BFL and are subject to change without notice. BFL makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, BFL assumes no responsibility for any losses or damages, whether direct or indirect which arise from the use of this information. BFL is under no obligation to update the information contained herein. The information should not be regarded as a substitute for the exercise of your own judgment. Please read the prospectus before investing. Commissions, trailing commissions, management fees and expenses all may be associated with exchange-traded fund investments. Please read the prospectus before investing. Exchange-traded funds are not guaranteed, their values change frequently and past performance may not be repeated. Information contained in this document was published at a specific point in time. Upon publication, it is believed to be accurate and reliable, however, we cannot guarantee that it is complete or current at all times. Certain statements contained in this document constitute forward-looking information within the meaning of Canadian securities laws. Forward-looking information may relate to matters disclosed in this document and to other matters identified in public filings relating to the ETFs, to the future outlook of the ETFs and anticipated events or results and may include statements regarding the future financial performance of the ETFs. In some cases, forward-looking information can be identified by terms such as “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “intend”, “estimate”, “predict”, “potential”, “continue” or other similar expressions concerning matters that are not historical facts. Actual results may vary from such forward-looking information. Investors should not place undue reliance on forward-looking statements. These forward- looking statements are made as of the date hereof and we assume no obligation to update or revise them to reflect new events or circumstances. Given these uncertainties, investing in high-quality companies with financial strength and flexibility is more important than ever. We believe that focusing on equities with robust free cash flow generation ability is particularly important in the current environment. Free Cash Flow (FCF) represents the excess cash after a company pays its operating expenses and capital expenditures. |
