After a year in which a rapid rise in interest rates sent stock and bond prices plummeting, investors are focusing on quality. One way to do this is to look at free cash flow — and doing so can lead to better long-term returns for growth investors.
The Pacer US Cash Cows 100 ETF Cows
The glut has come as the Federal Reserve has cashed in on excess liquidity by raising interest rates in an effort to reduce inflation. Sean O’Hara, president of Pacer ETF Distributors, discusses the exchange-traded fund’s approach to stock selection during an interview.
Let’s start with four sets of total returns (with reinvested dividends) for the Cash Cow ETF against ETFs that track its benchmark, the Russell 1000 Value Index RLV.,
and S&P 500 SPX,
| ETF | anchor | 5 years till March 7 | 2023 to March 7 | 2022 | 5 years through 2021 |
|
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Pacer US Cash Cows 100 ETF |
Cowes |
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78% |
3% |
0% |
113% |
|
iShares Russell 1000 Value ETF |
IWD |
40% |
1% |
-8% |
68% |
|
SPDR S&P 500 ETF Trust |
Spy |
59% |
4% |
-18% |
132% |
|
Source: FactSet |
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Cash Cow ETF has been one of the best performers over the past five years. You can see that it held up very well during the 2022 bear market — and for the five years through 2021, when interest rates were low and liquidity was high, the fund outperformed the iShares Russell 1000 Value ETF IWD. Exhibited
But the SPDR S&P 500 ETF Trust lagged behind SPY,
Cash Cow has $12.9 billion in assets under management. That’s up from $2.6 billion a year ago.
O’Hara said stock valuations relative to earnings were very high when the ETF launched in 2016 and for several years thereafter. The idea for Cash Cows was to identify value stocks that would be better suited for the modern world.
Traditionally, stocks are placed in the “value” camp if they trade low relative to book value. But O’Hara and his colleagues at Pacer believe this measure doesn’t work very well, “because much of the value of the stock market today is based on intangible assets, not tangible assets, ” They said.
He Google’s parent company Alphabet Inc. Google cited
As an example: The company’s market value is “based on the fact that they dominated search and figured out how to dominate it. They’re intangible,” he said.
Broader stock-market indexes are weighted by market capitalization, so the biggest tech names tend to dominate during liquidity-driven bull markets. And even today, the SPDR S&P 500 ETF Trust – Apple Inc.,
Microsoft Corporation MSFT,
Alphabet Inc., Amazon.com Inc. Amazon
and Nvidia Corporation NVDA
– Make up 20% of the portfolio.
“It makes sense, when you think about the shift in the economy from manufacturing to a consumption, technology, brand, health-based economy — those things thrive on the intangible,” O’Hara said.
For cash cows, a rules-based stock-selection approach is based on trailing free-cash-flow return. A company’s free cash flow is its remaining cash flow after capital expenditures. This is money that can be used to pay dividends, buy back stock, or systematically or through acquisitions, or for other corporate purposes.
A company’s trailing free-cash-flow yield is the sum of its free cash flow per share for its last four reported quarters, divided by the current share price.
Cash Cow’s portfolio is restructured and rebalanced every quarter. The screen starts with the full Russell 1000 Index RUI
All financial stocks are removed from the largest publicly listed companies in the US, as free-cash-flow returns are generally not available to the industry. Then there’s a forward screen to eliminate any companies expected to post quarterly net losses over the next two years.
The remaining stocks are then ranked based on free-cash-flow yield, and the top 100 make up the final list. These are weighted by free-cash-flow yield, with a maximum weighting of 2% for any stock.
O’Hara said the free-cash-flow yield can be “a great predictor of what’s going on in the economic cycle.”
Even before big technology companies were showing signs of slowing growth, portfolios of cash cows were moving away from tech stocks, while companies in the energy, industrial, materials and healthcare sectors “rotated,” he said.
In addition to identifying undervalued stocks and moving in line with macroeconomic trends, this type of stock screening can signal trouble ahead if a company’s free-cash-flow yield is declining or if analysts anticipate further net losses. hopefully. For example, Cash Cow owns Intel Corp. INTC shares were
From September 2020 to December 2021. Intel cut its dividend by 66% last month.
Here are the fund’s top 10 holdings as of March 8. Some have weightings of more than 2% due to share-price growth since the fund’s last rebalancing in December.
| company | anchor | % of portfolio net assets |
|
Meta Platforms Inc. class a |
meta |
3.1% |
|
Nucor Corporation |
nue |
2.3% |
|
LyondellBasell Industries NV |
LYB |
2.3% |
|
Marathon Petroleum Corp. |
mpc |
2.3% |
|
Dow Inc. |
Dow |
2.2% |
|
Valero Energy Corporation |
VLO |
2.2% |
|
Exxon Mobil Corp. |
XOM |
2.1% |
|
PayPal Holdings Inc. |
PYPL |
2.1% |
|
Cisco Systems Inc. |
csco |
2.0% |
|
Altria Group Inc. |
MO |
2.0% |
|
Source: Pacer ETF |
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Click on tickers for more information on each company or ETF.
Read Tommy Kilgore’s detailed guide to the wealth of information available for free on the Marketwatch quote page.
Pacer has also applied the Cash Cow strategy to other groups of stocks, including the Pacer US Small Cap Cash Cows 100 ETF CALF.
and Pacer Global Cash Cow Dividend ETF GCOW,
Don’t miss: 20 income-generating stocks that the numbers say could become elite Dividend Aristocrats
Credit: www.marketwatch.com /