There Is A Lot Of Money Flowing Into This Cash-Cow Stock Strategy

After the end of the stock market bull market, the Pacer U.S. Cash Cows ETF has performed well.

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Investors are concentrating on quality after a year in which a sharp increase in interest rates led bond and stock prices to plunge. Looking at free cash flow is one way to achieve this, and doing so might result in superior long-term return for growth investors.

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The Federal Reserve has tightened restrictions on excessive liquidity by rising interest rates in an effort to reduce inflation, which has benefited the Pacer U.S. Cash Cows 100 ETF COWZ. Sean O'Hara, president of Pacer ETF Distributors, explained the exchange-traded fund's strategy to stock selection during an interview.

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Let's start with four comparisons of the Cash Cows ETF's total returns (with dividends reinvested) to those of the Russell 1000 Value Index RLV and the S&P 500 SPX, two ETFs that mirror the benchmark.

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Over the previous five years, the Cash Cows ETF has outperformed all others. You can see that it held up quite well during the bad market of 2022 — and that over the 5 years through 2021, when rates of interest remained very low and liquidity was robust, the fund beat the iShares Russell 1000 Value ETF IWD but behind the SPDR S&P 500 ETF Trust SPY.

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$12.9 billion in assets are being managed by Cash Cows. This is an increase from $2.6 billion last year.

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O'Hara claimed that stock valuations in relation to earnings were at extremely high levels at the time the ETF was introduced in 2016 and for several years afterward. To find value stocks in a method that is more appropriate for the contemporary environment, Cash Cows was created.

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If a stock trades cheaply compared to its book value, it is typically classified as a "value" stock. The stock market's worth today is largely dependent on intangible assets rather than tangible assets, according to O'Hara and his colleagues at Pacer, thus they don't think this approach is very effective.

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He cited Alphabet Inc., the parent firm of Google. Using GOOGL as an example, its market value is based on the fact that it mastered the art of dominating search. He answered, "They are intangibles.

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The largest tech names thrived during the liquidity-driven bull market since the main stock market indices are weighted by market capitalisation. Yet even today, Apple Inc. is one of the top five businesses owned by the SPDR S&P 500 ETF Trust. Microsoft Corp., Apple Inc. Amazon.com Inc., Microsoft, and Alphabet Inc. Nvidia Corp. and Amazon Inc. Twenty percent of the portfolio is NVDA.

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It makes sense when you consider how the economy has changed from manufacture to consumption, technology, branding, and the health-based economy all depend on intangibles, according to O'Hara.

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The rules-based stock selection methodology for Cash Cows is based on trailing free-cash-flow yields. Free cash flow is the amount of a company's cash flow that is left over after capital expenditures. With this money, the company could pay dividends, buy back shares, grow organically or via acquisitions, or pursue other corporate objectives.

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The total free cash flow per share for a company's most recent four reported quarters divided by the stock price results in the trailing free-cash-flow yield.

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Every three months, the Cash Cows portfolio is rebuilt and rebalanced. The screen opens with the whole Russell 1000 Index RUI of the biggest publicly traded U.S. corporations. Then, since the business doesn't normally offer free-cash-flow yields, all financial stocks are eliminated. A forward screen is then used to weed out any companies that are predicted to report any quarterly net losses during the following two years.

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The top 100 stocks are then chosen from the remaining stocks based on trailing free-cash-flow yield. Free-cash-flow yield is used to weight them, with a cap of 2% for any given stock.

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Free-cash-flow yields, according to O'Hara, are "a superb predictor of what is happening in an economic cycle."

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Well before large technology companies began signaling slower rates of growth, the Cash Cows portfolio had been tilting away from technology companies, while businesses in the energy, industrial, material and health sectors had "rotated in," he said.

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This kind of stock screening can indicate trouble ahead if a company's free-cash-flow yield is dropping or if analysts anticipate future net losses, in addition to spotting inexpensive stocks and following broad economic trends. For instance, Cash Cows owned stock in Intel Corporation. From September 2020 until December 2021, INTC. Last month, Intel reduced its dividend by 66%.

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These are the top 10 holdings of the fund as of March 8. Due to rises in share prices since the fund's last rebalancing in December, several had weightings above 2%.

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The Pacer U.S. Small Cap Cash Cows 100 ETF CALF as well as the Pacer Global Cash Cows Dividend ETF GCOW are two examples of how Pacer has applied the Cash Cows strategy to various stock categories.