Technology stocks fluctuate repeatedly, can high dividends only seek stability? Understanding the two stock selection strategies of dividend yield and free cash flow

Introduction: Since the beginning of this year, U.S. tech stocks have experienced significant fluctuations multiple times, and market concerns about AI valuations and capital expenditures continue to brew. In addition to frequently switching between "chasing tech" and "defending dividends," investors can also take a different perspective: to see whether companies can continuously generate cash and return it to shareholders.

This article introduces the meanings, uses, and limitations of two stock selection indicators: dividend yield and free cash flow, and uses the Southern Eastern FTSE East-West Stock Select ETF (03441.HK) as an example to break down the "high dividend in Hong Kong stocks + free cash flow in U.S. stocks" barbell allocation strategy. According to issuer information, as of September 30, 2026, the index tracked by this product has a total return of approximately 30.8% year-to-date, with a maximum drawdown of about 8% over the past year.

I. Avoiding Corrections is Harder Than Expected

In July of this year, the Nasdaq 100 index fell about 11% within a month, entering a technical correction. For investors concentrated in tech stocks, such corrections are directly reflected in their accounts.

The reason lies in the composition structure: if holdings are concentrated in a single market or style, the rise and fall of the portfolio essentially depend on the performance of that single asset. When tech stocks rise, the portfolio performs well, but it also faces pressure during corrections.

Switching between different styles may seem like a way to avoid corrections, but the actual operational difficulty is not low. Investors need to simultaneously judge when to exit and when to re-enter, and misjudgments may lead to missing rebounds, while frequent trading can also increase costs.

Compared to predicting when styles will rotate, understanding where the returns of different assets come from may be more valuable. Let's start with two indicators that measure a company's cash generation ability.

II. Dividend Yield: How Much Cash Does the Company Distribute?

What is Dividend Yield?

Dividend yield is the ratio of cash dividends paid per share to the current stock price, used to measure how much cash return one might receive annually based on the current price.

For example, if a stock is priced at 50 Hong Kong dollars and paid a dividend of 2.5 Hong Kong dollars per share over the past year, the dividend yield is 5%.

Why is Dividend Yield Commonly Used for Stock Selection in Hong Kong?

In the Hong Kong market, companies in industries such as utilities, banking, infrastructure, and transportation have relatively mature businesses, and the reinvestment needed for expansion is limited. They typically distribute a larger proportion of profits to shareholders in the form of cash dividends. Therefore, dividend yield is a commonly used indicator to measure the ability of such companies to return to shareholders.

Another mechanism characteristic of screening by dividend yield is: when stock prices fall, the dividend yield rises, making these stocks more likely to be included in the portfolio; when stock prices rise, the dividend yield falls, which may lead to their removal. This somewhat creates a "buy low, sell high" effect.

Common Traps of High Dividends

A high dividend yield does not necessarily indicate high investment value. Investors need to be aware of:

• "High dividends" caused by a significant drop in stock price: If the dividend yield rises mainly due to a sharp decline in stock price, it may indicate deteriorating business operations, and future dividends may not be sustainable.

• Sustainability of dividends: One can check the payout ratio (the proportion of dividends to profits) and the history of dividends. Companies that have consistently paid dividends higher than profits or cash flow may find it difficult to maintain those dividends.

• Industry cycles: Some cyclical industries pay more dividends during peak economic conditions, but dividends may significantly decrease when the industry weakens.

III. Free Cash Flow: How Much Cash Can the Company Distribute Freely?

What is Free Cash Flow?

Free cash flow is the cash that a company can freely use after paying operating expenses and necessary investments (mainly capital expenditures).

For example, if a company generates 10 billion U.S. dollars from operating activities in a year and spends 3 billion U.S. dollars on capital expenditures such as building factories and purchasing equipment, the free cash flow is 7 billion U.S. dollars. This money can be used for dividends, share buybacks, debt repayment, or reinvestment.

Compared to accounting profits, free cash flow reflects the actual cash received and available for use by the company, and is less affected by accounting treatment methods, making it a common measure of profit quality.

What is Free Cash Flow Yield?

Free cash flow yield is the ratio of a company's free cash flow to its market capitalization, which can be understood as: how much disposable cash a company can generate annually based on the current stock price. It is similar in concept to dividend yield, but measures how much cash a company "can distribute," rather than just "how much it has actually distributed."

Why is Free Cash Flow Commonly Used for Stock Selection in the U.S.?

U.S. companies have a more diverse range of methods for returning capital to shareholders. In addition to dividends, many companies more commonly return capital through share buybacks. If one only looks at dividend yield, they may miss companies that do not pay high dividends but consistently engage in large-scale buybacks. Free cash flow can more comprehensively reflect a company's ability to return capital to shareholders.

Combining Current Market Conditions: How Capital Expenditures Affect Free Cash Flow

One topic of concern in the market this year is the continued rise in capital expenditures by AI-related companies. As can be seen from the calculation of free cash flow, the larger the capital expenditures, the lower the free cash flow during the same period.

This does not mean that companies with high investments are bad; capital expenditures may lead to growth in the future. However, for stock selection methods based on free cash flow, companies with significantly increased capital expenditures may see their rankings decline. Understanding this helps to grasp the performance differences of such strategies in different market conditions.

Limitations of Free Cash Flow

• Single-year distortions: A company may have concentrated investments or collections in a certain year, which can make that year's free cash flow significantly higher or lower.

• Not applicable to growth-stage companies: Companies in a rapid expansion phase may have low or even negative free cash flow, but this does not necessarily indicate poor operations.

• Does not equal shareholder returns: A high free cash flow does not guarantee that the company will return all of that cash to shareholders, as it may also be used for acquisitions or retained as cash.

IV. Comparison of Dividend Yield and Free Cash Flow

Both indicators focus on the same question: Can the company continuously generate cash and return it to shareholders? The difference lies in the perspective of observation.

|---------|-------------------------|----------------------| | Comparison Item | Dividend Yield | Free Cash Flow Yield | | What it measures | How much cash the company has actually distributed in dividends | How much cash the company can freely use | | Calculation method | Cash dividend per share ÷ Stock price | Free cash flow ÷ Market capitalization | | Commonly used in | Markets and industries with strong dividend traditions, such as Hong Kong utilities and banking | Markets where buybacks are more common, such as U.S. stocks | | Characteristics of selected companies | Mature businesses with stable dividends | Strong cash generation ability, broader industry distribution | | Main limitations | A significant drop in stock price may cause an inflated dividend yield | Single-year distortions may occur, not suitable for high-growth companies |

V. Putting Both Types of Assets Together: "Barbell" Allocation Strategy

What is Barbell Allocation?

Barbell allocation refers to placing two types of assets with significantly different styles in the same portfolio, like the ends of a dumbbell: one end is defensive, such as stable high-dividend assets; the other end is aggressive, such as companies with growth potential.

The two types of assets are driven by different factors, and their movements are not completely synchronized. When one type of asset corrects, the other type may perform relatively steadily, giving the overall portfolio a chance to have lower volatility than holding a single style.

This allocation also involves trade-offs: when one type of asset rises significantly, the portfolio may only have partial funds participating, potentially underperforming compared to a concentrated holding of that asset type.

How to Achieve This?

Investors can explore two methods:

• Build it themselves: Buy high-dividend stocks or related ETFs, as well as large U.S. companies or related ETFs, deciding the proportions and periodically rebalancing themselves. This offers higher flexibility but requires self-selection, tracking, and adjustments.

• Use rule-based ETFs: Some ETFs have already placed these two types of assets into the same portfolio according to established rules and periodically adjust their components. Investors do not need to manage the proportions themselves but must accept the product's established rules.

Example: Rule-Based Combination of Hong Kong High Dividends and U.S. Free Cash Flow

Taking the Southern Eastern FTSE East-West Stock Select ETF (03441.HK) as an example, the index tracked by this product allocates about 60% to local high-dividend stocks in Hong Kong, selected based on dividend yield, mainly distributed in utilities, finance, industry, and real estate; about 40% is allocated to large U.S. companies, excluding those with negative free cash flow, lower quality, or high volatility from the Russell 1000 index, and selecting the top 100 with better free cash flow performance. The weights of the two markets are determined by index rules and are not actively adjusted based on market judgments.

In terms of returns, according to issuer information, as of September 30, 2026, the index has a year-to-date return of approximately 30.8%, with a return of about 36.7% over the past year. On the product level, 03441 has cumulatively risen over 30% since being included in the ETF Connect in November 2025, ranking first in return among all southbound ETFs.

According to issuer information, as of September 30, 2026, the index's maximum drawdown over the past year is about 8%, lower than the same period's Nasdaq 100 index, Hang Seng Index, and S&P 500 index, indicating its historical drawdown is relatively low. It is important to note that this is the past performance of the index and does not represent future performance of the product; actual fund returns will also be affected by fees, tracking errors, and other factors.

VI. Before Investing, It is Recommended to Consider the Following Points

• Do I understand the screening criteria for the selected assets? Whether screening by dividend yield or free cash flow, the selected companies and their performance in different market conditions may vary greatly.

• Is there already an overlap in my current holdings? If I already hold a significant number of high-dividend stocks or large U.S. stocks, adding similar assets may increase concentration.

• Can I accept relatively underperforming in a rising market? Diversified allocation may reduce volatility but could also lower participation in strong markets.

• What are the actual trading conditions of the product? Compare management fees, buy-sell spreads, trading volumes, tracking performance, and dividend arrangements to avoid making decisions based solely on recent price increases.

Conclusion

High-dividend assets are often seen as defensive tools, while tech stocks are often viewed as sources of growth. However, from the perspective of "can companies continuously generate cash," both can be understood using similar logic: dividend yield measures how much cash a company has actually distributed, while free cash flow measures how much cash a company can potentially distribute.

Putting both types of assets in the same portfolio can reduce dependence on a single market or style, but it also means lower participation when one type of asset rises strongly. At the same time, risks such as industry concentration, interest rate changes, exchange rates, and market volatility still exist.

Whether building a portfolio independently or using rule-based products, one should first understand the screening criteria, risks, and costs, and then determine whether it aligns with their investment goals.

(The product information related to this article, 03441.HK, is provided by Southern Eastern Asset Management Limited.)

Risk Warning: This article is for general market information and investor education only and does not constitute investment advice, nor is it an offer, solicitation, or recommendation to buy or sell any securities or funds. Past performance does not guarantee future results. Investments in securities and ETFs may result in the loss of principal, and investors should read the relevant product documents and fully understand the risks before investing. The products and services mentioned may not be recognized or registered in all jurisdictions and are not offered to persons in jurisdictions where such offers are prohibited or restricted by applicable law. Please refer to the applicable laws in your location.