“I determined this was an added benefit — as opposed to underweighting them — when I read a couple of studies that indicated most stocks under-perform the index,” Del Vecchio said in the article.

For F-rated stocks, Del Vecchio highlights some glaring red flags, such as rising inventories with moderate revenue growth, lower sales trends, deteriorating margins and high amounts of revenue from unbilled receivables, which suggests aggressive revenue recognition.

On the other hand, A-rated stocks show strong balance sheets, sold cash flow, sustainable buybacks and dividends, and gross profit and EBITDA margins are rising.

Del Vecchio anticipates FLAG will see higher turnovers, up to 30% annually, due to changes in F-rated stocks, but it is still lower many actively managed ETFs.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

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