A company's ability to generate free cash flow and maintain a solid balance sheets are important considerations in the stock selection process. The Pacer US Cash Cows 100 ETF COWZ is one exchange traded fund that puts the benefits of prodigious cash flow generation to work for investors.
COWZ, one of several cash flow ETFs in the Pacer stable, follows the Pacer US Cash Cows 100 Index.
What Happened
COWZ components are large- and mid-cap names from the Russell 1000 Index with impressive free cash flow yields. As of the end of the third quarter, the free cash flow yield on the Pacer US Cash Cows 100 Index was 7.88 percent compared with 3.41 percent for the Russell 1000, according to Pacer data.
Holdings in the Pacer US Cash Cows 100 Index are weighted by free cash flow yield and their weights in the benchmark are capped at 2 percent.
Why It's Important
While COWZ scuffled a bit this year, historical data indicate focusing on free cash flow is a strategy that rewards investors, particularly when interest rates rise.
“The top 100 highest yielding free cash flow companies in the US large-cap Russell 1000 Index outperformed the broad index by nearly 13% in periods of rising rates and by nearly 3% in periods of falling rates between December 31, 1991 and September 28, 2018,” according to index provider FTSE Russell.
The focus on cash flow gives COWZ different sector exposures than the Russell 1000. COWZ devotes 31.36 percent of its weight to technology stocks compared to 20.21 percent in the Russell 100. The three largest sector weights in COWZ are technology, consumer discretionary and health care. Those sectors combine for over 68 percent of the ETF's weight, but just 45 percent of the Russell 1000.
What's Next
Investors don't have to pay up for COWZ and its cash flow benefits. At the end of the third quarter, the ETF had a price-to-earnings ratio of 13.12 compared to 22.11 on the Russell 1000.
“Having free cash flow means a company is able to fund itself and is therefore not reliant on the markets for funding,” said Michael Mack, portfolio manager at Pacer Advisors. “Given that most high free cash flow companies are self-funding and have strong balance sheets, it is not surprising that they have historically outperformed the broad market during periods of rising rates.”
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