A company’s ability to generate free cash flow is a valuable metric for investors looking for financial sturdy firms with strong credit ratings and the potential to initiate and grow dividends. The Pacer US Cash Cows 100 ETF (BATS: COWZ) is an exchange traded fund that focuses on free cash flow generation.
COWZ tries to reflect the performance of the Pacer US Cash Cows 100 Index, which is comprised of large- and mid-cap U.S. companies with high free cash flow yields, or those commonly referred to as “cash cows.”
The underlying index selects companies from the Russell 1000 Index and screens those based on average projected free cash flows and earnings over each of the next two fiscal years, excluding financial companies other than real estate investment trusts.
Some data points indicate COWZ could be a rewarding strategy as the Federal Reserve moves forward with plans for additional interest rate increases.
“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 COWZ Call
Component companies are ranked by free cash flow yield for the trailing twelve month period, and equity securities of 100 companies with the highest free cash flow yield are included in the underlying index. Holdings are also weighed in proportion to their trailing twelve month free cash flow with a capped 2% of the weight of the index for any individual company.
While COWZ has a free cash flow yield that is significantly above the Russell 1000’s, the ETF’s price-to-earnings ratio of 13.12 is well below the 22.11 found on the Russell 1000, indicating investors do not have to pay up to embrace companies with strong cash flow.
“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 of 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.”
For more on smart beta ETFs, visit our Smart Beta Channel.