In a market where stocks can go parabolic on little more than hype, it’s important to remember that fundamentals still matter, and the COWZ ETF (BATS:COWZ) proves this. The $19.0 billion ETF, which focuses on free cash flow yield, has beaten the broader market over the past five years with an excellent 17.7% annualized return over this time frame (as of December 31).
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I’m bullish on COWZ based on its proven track record, its rigorous investment approach, and the attractive valuation of its portfolio.
What Is the COWZ ETF’s Strategy?
According to the ETF’s sponsor, Pacer ETFs, COWZ “aims to provide capital appreciation over time by screening the Russell 1000 for the top 100 companies based on free cash flow yield.”
Free cash flow is defined as the cash a company has left over after paying for expenses, interest, taxes, and long-term investments. This cash can be used to create value for shareholders by making share repurchases, paying dividends, or even making acquisitions.
Free cash flow yield is derived by taking a company’s free cash flow per share and dividing it by its share price. Generally speaking, the higher the free cash flow yield, the more attractive the stock looks.
Pacer explains, “Finding stocks with room to grow can be difficult when the market is overvalued,” but “Using Free Cash Flow Yield to indicate whether a company is producing more cash than it needs to run its business” allows for growth opportunities through other investments.
Rigorous Investment Process
Pacer uses a rigorous investment process and an extensive set of screens to create its portfolio. It starts with an investment universe of the 1,000 stocks in the Russell 1000 Index. These stocks have a relatively high average price-to-earnings ratio of 24.7 and a free cash flow yield of just 3.2% (as of the fund’s December 31 rebalance).
COWZ then narrows this list down to the 100 companies with the highest free cash flow yields over the trailing 12 months, which significantly improves these metrics — this pared-down group of 100 stocks has a much lower price-to-earnings ratio of 11.1 and a much higher free cash flow yield of 8.3%.
COWZ then weights these 100 companies by their trailing free cash flow over the past 12 months, with a 2% cap. By doing this, it again improves the valuation and free cash flow yield of its holdings, as the portfolio has an average price-to-earnings ratio of just 10.0 and a slightly higher free cash flow yield of 8.6%.
By running these screens, COWZ creates a diversified portfolio of stocks that produce significant free cash flow and trade at a significant discount to the broader market.
The COWZ ETF’s Portfolio
COWZ owns 100 stocks, and because it caps positions at 2% when it rebalances, there is very little concentration in the fund, as its top 10 holdings account for just 21.1% of assets. Below is an overview of the COWZ ETF’s top 10 holdings using TipRanks’ holdings tool.
As you can see, COWZ owns a variety of stocks from sectors that currently trade at lower valuations, including energy stocks like Valero Energy (NYSE:VLO), Philips 66 (NYSE:PSX) and Marathon Petroleum (NYSE:MPC), homebuilders like Lennar (NYSE:LEN) and D.R. Horton Inc. (NYSE:DHI), and healthcare names like CVS Health (NYSE:CVS) and AbbVie (NYSE:ABBV).
But this doesn’t mean that tech stocks are absent from the fund. Qualcomm (NASDAQ:QCOM) is the top holding, and Cisco (NASDAQ:CSCO) also makes an appearance in the top 10.
While these stocks typically have lower valuations and higher free cash flow yields than the broader market, they also boast a strong collection of Smart Scores. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks a score from 1 to 10 based on eight market key factors. A score of 8 or above is equivalent to an Outperform rating.
An impressive seven out of the COWZ ETF’s top 10 holdings feature Outperform-equivalent Smart Scores of 8 or higher, including AbbVie, CVS, and Lennar, which top the charts with ‘Perfect 10’ Smart Scores.
Overall, COWZ has a Neutral ETF Smart Score of 7.
Beating the Market
As discussed above, COWZ has an impressive history of performance. As of December 31, the free-cash-flow-yield-focused ETF has generated a three-year annualized return of 17.9% and a five-year annualized return of 17.7%. These results compare favorably with the broader market over the same time frame. For comparison, the Vanguard S&P 500 ETF (NYSEARCA:VOO) returned 10.0% over the past three years and 15.7% over the past five years.
The fund launched in 2016, so we don’t yet know if it will beat the market over a 10-year time frame, but so far, the results have been impressive.
Is COWZ Stock a Buy, According to Analysts?
Turning to Wall Street, COWZ earns a Moderate Buy consensus rating based on 62 Buys, 32 Holds, and seven Sell ratings assigned in the past three months. The average COWZ stock price target of $57.67 implies 11.5% upside potential from current levels.
What’s COWZ’s Expense Ratio?
COWZ has an expense ratio of 0.49%. This means that an investor in the fund will pay $49 on a $10,000 investment annually. Assuming that the fund maintains this expense ratio and returns 5% per year going forward, an investor allocating $10,000 to COWZ will pay $274 in fees over the course of five years.
While this isn’t cheap, it’s in the middle of the road, as there are also many ETFs that charge higher fees. Plus, COWZ has beaten the market over the past three and five years, so it can make a credible case that this fee is justified.
The Takeaway
While there is no shortage of chatter about a frothy market where stocks seemingly go into orbit on little more than hype, the COWZ ETF proves that focusing on sound fundamentals like free cash flow yield and running a rigorous investment process to screen for the best companies (according to effective metrics) can pay off.
COWZ has proven this by beating the market over the past three and five years. I’m bullish on COWZ and consider it a building block any investor can feel good about including in their portfolios based on its strong performance, extensive screening process, the attractive valuation of its holdings, and the strong Smart Scores that its top holdings garner.
Furthermore, while not cheap per se, its expense ratio is reasonable for the results it has achieved, and as an added bonus, the ETF features a 1.9% dividend yield.
