The Free Cash Flow Quality Model (FCFQM)

As a quality investor you believe that the best companies – those of highest “quality” – are the ones most likely to outperform the market over time.

We agree with you.

Countless other asset managers and investment firms agree with you, too.

The question is: What is the best measure of quality?

For most asset managers, assessments of quality are based on company earnings.

At FCF Advisors, the factors in our proprietary Free Cash Flow Quality Model (FCFQM) are centered on free cash flow.

Research has shown that the FCFQM provides a more reliable prediction of a company’s profitability than other methods. In addition, the quality companies uncovered by FCFQM tend to have very strong ESG (Environment, Social, and Governance) profiles.

Why develop
a different approach?

Most quality investors rely on company earnings as a key component of their valuation models

But company management has significant discretion when it comes to reporting earnings

If you cannot have confidence in the inputs to your model, how can you have confidence in the outputs

What is FCFQM?

The Free Cash Flow Quality Model is a multi-factor model featuring a unique combination of quality measures informed by our proprietary research

Free Cash Flow Profitability

Quality of Earnings

Cash Flow-Based Financial Strength

Free Cash Flow Quality Model (FCFQM)

Why does FCFQM find winners more consistently?

FCFQM relies on free cash flow rather than earnings

Free cash flow is the cash generated by a company through its operations after accounting for capital expenditure on fixed assets.

It is far less open to manipulation by management and our research shows that it has been a better predictor of medium- to long-term out-performance. It is therefore a core component of FCFQM.

FCFQM is forward looking

FCFQM has been built to predict strong profitability that will persist into the future.

Traditional quality managers tend to focus only on companies that have been profitable and stable in the past.

FCFQM is less affected by cycles

FCFQM selects stocks with profitable growth potential. An investment strategy constituted by such stocks, with proper portfolio construction technique, is likely to have a higher information ratio throughout the cycle.

Portfolios built by legacy quality managers tend to overweight low-beta stocks with higher sensitivity to the economic cycle.