When the COWZ come home!
By David Nelson, CFA CMT
War in Ukraine continues to take its toll on equity prices and with-it investor sentiment. The missile strike hitting a Ukrainian military base near Poland a NATO ally adds to those concerns. If the conflict were to breach the border even through miscalculation it could trigger article 5 potentially putting U.S. and NATO forces in direct conflict with the Russian military.
Market fundamentals or even the Fed’s next move seem to matter little in the context of geopolitical chaos. Most of the financial press this week will be covering the Ukraine, Russia, Oil, Inflation, Sanctions, China, Chemical Warfare and a list of geopolitical concerns that could frighten even Warren Buffett.
Let’s talk about a story that isn’t getting much press and could make you some money once the fog of war burns off.
When the COWZ come home
In falling markets investors are often obsessed with timing the bottom. Is it too early to get into Apple (AAPL), Tesla (TSLA) or Amazon (AMZN)? Surely Peloton (PTON) must have bottomed. It’s off -87% from the highs. Sometimes we are so focused on what isn’t working we miss something right under our nose that is.
Data by FactSet
Much has been written about the push to toward value stocks as high valuation NASDAQ darlings continue to face an uphill battle in the face of an aggressive Fed determined to regain its credibility.
If we drill down further into the value camp, we can actually identify the factor of choice that is producing some of the best returns.
Free Cash Flow (FCF): A company’s cash flow from operations minus capital expenditures (expenses, interest, taxes, and long-term investments)
If we take Free Cash Flow and divide it by the enterprise value (EV) of the company, we come up with Free Cash Flow Yield.
COWZ vs S&P 500 – 2 Years
Data by FactSet
To see how this one factor is putting money in the bank, look no further than Pacer’s US Cash Cows 100 ETF (COWZ.) The return to stock fundamentals and away from pure price momentum started in late 2020 and hasn’t looked back. It should come as no surprise that the outperformance kicks in shortly after Pfizer (PFE) announced early data from it’s successful COVID-19 vaccine.
Data by FactSet
Today the spread in performance between companies with high Free Cash Flow yields and the S&P 500 continues to widen. Even in the backdrop of War (COWZ) is up just over 2% year to date vs a large cap universe down more than -11%.
For Pacer, the process seems quite simple. Start with the Russell 1000 and continue to screen down to the 100 companies with the highest Free Cash Flow yields on a trailing 12-month basis.
No Apple, Microsoft or Amazon here.
Top holdings include Occidental (OXY), Conoco (COP), Exxon (XOM), Archer Daniels (ADM) and Freeport Mcmoran (FCX)
Free Cash Flow is a key factor for many quant strategies and certainly an important one for value investors. Pacer has taken the concept a step further putting it on steroids. I can’t tell you how long their strategy will continue to outperform but given the current geopolitical and economic backdrop you could do worse than a value strategy focused on some of the basics of fundamental investing.
*At the time of this article some funds managed by David were long COWZ, ADM, PFE, AAPL and MSFT