By Spencer Jakab

Fed governor Lisa Cook is surely happy that she gets to keep her job, but new Chair Kevin Warsh, and bond investors everywhere, are also probably pleased. The Supreme Court ruling bolsters the central bank's independence. Stocks like stability too, and also the lull in fighting with Iran. The Dow hit a fresh record Monday. Stock futures are muted on the final day of an extraordinarily strong second quarter.

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Improving a simple formula

In a world awash with gimmicky new exchange-traded funds — more than 1,000 launched in the U.S. just last year — an unflashy idea has found surprising success.

Companies such as Pacer ETFs and Victory Capital have attracted tens of billions of dollars to funds focused on free cash flow yield. It's a welcome development now that old-school value investing seems to have lost its magic.

Instead of trying to buy a dollar of assets or earnings for 60 cents, the funds focus on how much cash companies generate beyond their investment needs. Some of the world's most-respected investors, including Warren Buffett, Charlie Munger, Terry Smith, Bill Nygren and Joel Greenblatt have stressed distributable cash over accounting profits.

Funds focusing on free cash flow yield are performing well and getting rewarded with inflows in a market otherwise obsessed with AI. But any technique that boils security selection down to a simple screen is bound to get some things wrong.

One is failing to adjust for share-based compensation since it's a noncash item. The stock issuance still costs shareholders, and it often soaks up extra cash they could receive too. Companies usually buy back the issued stock on the open market.

"If compensation isn't an expense, what is it?," asked Buffett in his 2015 letter to shareholders.

Several large tech companies, including some that can be found in Pacer and Victory's portfolios, have very different FCF yields before and after taking it into account.

Atlassian, for example, sported a seemingly decent yield of 3.4% at the beginning of this year, but one barely above zero after subtracting share awards. Uber had a 5.6% yield, but that was a full percentage point lower after share awards. Amazon and Snowflake both went from positive to negative yields after that adjustment.

It's "totally insane not to" include share-based compensation in FCF calculations, says Meb Faber, co-founder and chief investment officer of Cambria Investment Management. Faber wrote a book on the subject, " Shareholder Yield," and runs a suite of well-performing ETFs based on the idea.

But is it necessarily worth adding a layer of complexity to successful funds? Mannik Dhillon, head of ETFs at Victory Capital, says the firm's own backtests show basically no difference in performance. He says the issue is "on their radar," though.

Silicon Valley is where the chunkiest share awards tend to be, so it's possible the strong performance of almost anything tech-related has outweighed their ill effects so far. The ETFs also hold enough other companies that their performance won't be dragged down much by a handful handing out lots of share awards.

It's certainly something individual investors picking stocks on the basis of free cash flow should consider. Winning formulas can be simple, but occasionally they're a little too simple.

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Stocks I'm Watching

Super Micro Computer , Applied Materials , Sandisk : Shares of companies tied to the AI build-out advanced premarket as investors pile back into tech shares.

A.P. Moller-Maersk : The Danish shipping giant raised its full-year guidance, citing strong demand in the container market and an increase in spot market rates. Shares ticked up.

Abivax : The French biotech released new data reassuring investors about the safety of its experimental ulcerative colitis treatment; its shares went flying, reversing a recent slump.

🔎 Constellation Brands : The alcohol giant will report quarterly results before the opening bell. Nike will report after the close.

One Big Chart

Comcast is finally undoing its own bundle. Investment bankers might be salivating at the prospects, but ending one problematic combination doesn't automatically justify, or open the floodgates, for more.

What I'm Reading

  • Big American companies' profit margins have never been higher. Stock-market bulls cite that as reassuring at a time of high stock valuations. (WSJ)
  • War can be lucrative. JPMorgan Chase launched an initiative to invest $10 billion of its capital directly into national security firms. (WSJ)
  • They're in their 60s and their student loans won't let them retire. (WSJ)
  • Reality comes knocking: Michael Saylor's Strategy has abandoned its 'never sell bitcoin' mantra in a bid to outlast crypto winter and stay solvent. (WSJ)
  • Once the gold standard, the University of Michigan's survey of consumer sentiment seems broken. Why? (Nate Silver)

Today in Markets History

📰 On this day in 1932, the total market value of all stocks listed on the New York Stock Exchange scraped bottom at $15.6 billion, down from $89.7 billion on Sept. 1, 1929.

Beyond the Newsroom

WSJ | Buy Side: These pro-approved golf shirts for men and women are lightweight and many offer protection from the sun's rays.

About Me

Business and finance have fascinated me for a long time. Before writing this newsletter, I edited The Wall Street Journal's Heard on the Street team for a decade, wrote two investment books and managed a team of stock analysts at a global investment bank.

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