COWZ March Reconstitution: High-Quality Deep Value Play Remains (BATS:COWZ)

Investment Thesis

For the second straight time, the Pacer US Cash Cows 100 ETF (BATS:COWZ) substituted nearly two dozen holdings in its 100-stock portfolio during its scheduled quarterly rebalancing process. One of the most significant changes was a 5% reduction in Energy exposure, down from 28% previously, which I listed as a key reason for my latest “hold” rating three months ago. As usual, quality and value metrics remain strong, as COWZ has a solid 9.05/10 profit score and trades at just 12.75x forward earnings, competitive with free cash flow ETF peers VFLO, FLOW, and COWS. It’s one of the things I’ve come to appreciate about COWZ – it consistently hits its targets and is transparent about its strategy and objectives.

In this article, I will discuss the rebalance in more detail, analyze COWZ’s performance track record against some well-known large-cap value ETFs, share my perspective about whether COWZ’s fundamentals improved with the latest rebalance, and discuss how well it complements some broad-based Index funds you might own. I hope you enjoy the read.

COWZ Overview

Strategy Discussion

COWZ tracks the Pacer US Cash Cows 100 Index, selecting large-cap Russell 1000 stocks based on free cash flow yields. Pacer defines free cash flow as a company’s cash from operations minus capital expenditures and then divides that number by enterprise value (market cap plus debt less cash) to arrive at free cash flow yield. This value-oriented metric consistently emphasizes two key factors: quality and value, and as shown in the graphic below, it’s quite different than the metrics for broad-market Index funds like the iShares Russell 1000 Value ETF (IWD).

The Pacer US Cash Cows 100 Index has more than double the free cash flow yield (8.70% vs. 3.16%) and twice the dividend yield (2.42% vs. 1.24%) but trades at less than half the valuation (10.77x vs. 23.06x) compared to the Russell 1000 Index. For clarity, this screenshot from the Pacer website is outdated, but these differences are consistent quarter-to-quarter. You can keep checking this link for updates, which I expect Pacer will make on Monday.

Performance Snapshot

COWZ has seven full years under its belt, having launched on December 16, 2016. From January 2017 to February 2024, it gained an impressive 135%, ranking #3 in the large-cap value category behind the Siren DIVCON Leaders Dividend ETF (LEAD) and the WisdomTree U.S. Quality Dividend Growth Fund ETF (DGRW) but ahead of the Vanguard Dividend Appreciation Index Fund ETF (VIG).

Still, the log chart helps illustrate how COWZ wasn’t always a great ETF. A $10,000 investment in COWZ on January 1, 2017, declined to $9,578 on March 31, 2020, while LEAD, DGRW, and VIG gained 25-33%. COWZ’s high allocation to Energy stocks proved crucial as inflation ramped up, but now that inflation is decelerating, it might not make much sense anymore. I ask readers to be vigilant about performing-chasing and understand the sources for an ETF’s returns before judging if it’s an appropriate buy.

Regarding performance-chasing, ETF providers do it, too, though for different reasons. Recently, three ETFs have emerged with a similar free cash flow yield strategy, undoubtedly trying to grab a piece of COWZ’s $24.70 billion in assets under management:

• VictoryShares Free Cash Flow ETF (VFLO)
• Global X U.S. Cash Flow Kings 100 ETF (FLOW)
• Amplify Cash Flow Dividend Leaders ETF (COWS)

Competitors didn’t emerge until now because COWZ didn’t deliver impressive enough returns until recently, and launching an ETF takes time. So far, all three have outperformed COWZ since October 2023. However, this short period is hardly enough to judge which one is best. VFLO’s 20.90% total return is due to its stronger emphasis on growth and perhaps some good fortune, as it is only a 50-stock fund with 70% of its assets held in three sectors.

COWZ Analysis

COWZ Reconstitution Summary: 22 Additions

Effective March 18, 2024, COWZ will add 22 new stocks, as follows:

1. AT&T (T): 1.91%
2. Kenvue (KVUE): 1.88%
3. Cummins Inc. (CMI): 1.80%
4. Bunge (BG): 1.42%
5. DaVita (DVA): 1.01%
6. Ovintiv (OVV): 0.93%
7. Omnicom Group (OMC): 0.93%
8. Snap-on (SNA): 0.73%
9. Berry Global Group (BERY): 0.66%
10. V.F. Corp. (VFC): 0.63%)
11. Amdocs Ltd. (DOX): 0.53%
12. DocuSign (DOCU): 0.52%
13. Match Group (MTCH): 0.51%
14. Ingredion (INGR): 0.48%
15. Etsy (ETSY): 0.42%
16. Columbia Sportswear (COLM): 0.38%
17. Polaris (PII): 0.36%
18. Reynolds Consumer Products (REYN): 0.35%
19. RingCentral, Inc. (RNG): 0.24%
20. Teradata (TDC): 0.23%
21. YETI Holdings (YETI): 0.12%
22. IPG Photonics (IPGP): 0.12%

The median free cash flow margin for these 22 additions is 13.62%, about the same as the average 13.95% figure for all holdings. However, the primary metric I want to highlight is how these stocks have averaged an 18.64% price decline over the last three years. Furthermore, free cash flow isn’t necessarily increasing. It was negative for OMC, SNA, MTCH, and PII during the previous three years and in the low-single digits for VFC, ETSY, and IPGP. Therefore, one takeaway is that investing for free cash flow and free cash flow yield are two different things. While free cash flow margins are pretty solid across the board, these stocks were primarily added because their share prices declined.

COWZ Reconstitution Summary: 22 Deletions

While OVV was the sole Energy addition this quarter, 6/22 deletions were from that sector. I’ve bolded them below, and the net effect is a 5.14% reduction in Energy sector exposure.

1. QUALCOMM (QCOM): 2.33%
2. AbbVie (ABBV): 2.27%
3. Phillips 66 (PSX): 2.13%
4. D.R. Horton (DHI): 2.06%
5. Booking Holdings (BKNG): 1.98%
6. Pioneer Natural Resources (PXD): 1.94%
7. ConocoPhillips (COP): 1.87%
8. Dow Inc. (DOW): 1.85%
9. C.F. Industries Holdings (CF): 1.31%
10. Coupang, Inc. (CPNG): 1.04%
11. EQT (EQT): 0.74%
12. ADT (ADT): 0.54%
13. Juniper Networks (JNPR): 0.52%
14. Chesapeake Energy (CHK): 0.51%
15. EMCOR Group (EME): 0.50%
16. Range Resources (RRC): 0.39%
17. Incyte Corp. (INCY): 0.30%
18. Landstar System (LSTR): 0.24%
19. Seaboard Corp. (SEB): 0.18%
20. PHINIA (PHIN): 0.13%
21. Tripadvisor (TRIP): 0.11%
22. Maravai LifeSciences Holdings (MRVI): 0.11%

Unlike the additions, these 22 deletions averaged a 42.83% gain over the last three years and are up 8.72% YTD compared to the 8.18% YTD price return for the SPDR S&P 500 ETF Trust (SPY). These changes reinforce how COWZ follows a value-oriented strategy that often involves selling winning stocks and buying losing stocks.

Finally, consider the table below, which provides a quick snapshot of COWZ’s latest sector exposures, including the top three holdings in each sector (where applicable).

COWZ Fundamental Analysis

The following table highlights selected fundamentals for COWZ’s top 25 sub-industries, totaling 79.26% of the portfolio. From a diversification perspective, this is an improvement from the 87.77% figure pre-reconstitution, and most relates to decreases in Oil & Gas Exploration & Production (3.54%), Oil & Gas Refining & Marketing (2.28%), and Homebuilding (2.99%). I’ve frequently criticized COWZ for being too concentrated, so this change is welcome for me.

Here are three additional observations to consider:

1. Estimated sales and earnings per share growth remains negative at -0.83% and -1.87%, respectively. Since the free cash flow yield approach does not consider growth, it’s a bonus whenever COWZ scores well on this factor. Unfortunately, this is not one of those times, and the constituents’ 8.04% annualized five-year sales growth figure illustrates how much growth rates are estimated to decline. Also, COWZ’s one- and three-year sales growth rates were -6.44% and 15.14%, respectively. You can do the math and derive that COWZ’s constituents’ sales growth rates averaged 27.73% in 2021-2022 before declining to -6.44% in 2023, a remarkable 34.17% drop. Therefore, consider the argument that these stocks are attractively valued because their sales growth has dried up, and it’s challenging to call a bottom.

2. COWZ’s weighted average free cash flow margins are 13.97%, slightly better than VFLO, FLOW, and COWS. It also trades at 12.75x forward earnings (11.58x harmonic weighted average), so it’s undoubtedly attractively valued. Other large-cap value ETFs are just as cheap, like the Invesco S&P 500 Enhanced Value ETF (SPVU) and the Invesco S&P 500 Pure Value ETF (RPV). However, free cash flow margins for those ETFs are only around 6-7%, and overall profit scores, which I derived using Seeking Alpha Factor Grades, are lower than COWZ. On this metric, COWZ’s score is 9.05/10 compared to 8.88/10 and 8.09/10 for SPVU and RPV, respectively. Even though COWZ’s profit score dropped slightly with this reconstitution, I’m pleased the Index consistently emphasizes quality.

3. All four free cash flow ETFs complement broad-market ETFs well. COWZ has only a 5.61% overlap with SPY and a 10.79% overlap with the SPDR Portfolio S&P 500 Value ETF (SPYV). Its relatively low $50 billion weighted average market capitalization is the first clue it avoids most and often all mega-cap stocks and as this table highlights, VFLO, FLOW, and COWS do the same.

Investment Recommendation

COWZ underwent its scheduled quarterly reconstitution on Friday, with changes set to be effective Monday. I’m pleased, but not surprised, that COWZ remains a high-quality fund with an attractive valuation, and after reviewing the ETF several times, I take these positive features as a given. I’m also pleased with the 5% reduction in Energy exposure, but I still ask readers to consider low-cost Energy ETFs instead, as their fundamentals are just as good, if not better, than what COWZ offers for this sector. Nevertheless, COWZ has a low overlap with broad market ETFs, so I understand why many investors choose it as a high-quality satellite position.

Still, this latest reconstitution did not improve COWZ’s growth prospects. With earnings per share estimated to decline by 1.87% over the next year, COWZ is a pure value play that could either pay off handsomely or perform terribly, similar to its pre-pandemic track record. As a result, I’ve decided to reiterate my “hold” rating, and I look forward to answering your questions in the comments section below. Thank you for reading.