Stocks/International

Lyn Alden Schwartzer

Filtering Through the Noise to Find Value

A Look at Some Global Cash Cows

The highly successful hedge fund manager, Joel Greenblatt, once wrote a book called “The Little Book That Beats the Market”.

Some readers of this article have likely read it, but for those that have not, Greenblatt shows in the book that, historically, investing in the top few dozen companies with the highest earnings yields and the highest returns on invested capital (ROIC) tends to be a winning strategy.

No strategy outperforms all of the time, because if it did, everyone would crowd into it and it would stop outperforming. So, every good strategy goes through multi-year periods of underperformance, which shakes out all of the weak hands, and then it starts outperforming again. Whenever it’s falling behind, people start wondering if maybe the future is different, maybe the strategy won’t work anymore, and so forth. And perhaps one day they’ll be right, and value-type strategies will stop working forever.

But so far, value keeps showing up as a factor to watch. Small cap value stocks have been among the best performers over the past century. Companies with the highest shareholder yields have outperformed since at least the 1970’s, where the data goes back to on that particular approach. Greenblatt’s specific take on high earnings yield and high ROIC has also been a big performer for decades as well.

Lately, we’ve been in a global period where growth stocks have outperformed value stocks. Even my own portfolio has mostly been a “growth at a reasonable price” style rather than a deep value style, because those have been the companies with among the best forward risk-adjusted returns in my view.

Some Interesting ETFs

Pacer ETFs recently finished a set of ETFs called the Cash Cow Series that they have been building out for a few years, so that they now have a full set including a fund of funds. The first one came out in early 2016 and the final few came out several months ago.

This series of ETFs invests in non-financial companies that have the highest ratio of free cash flow to enterprise value, which includes market capitalization and debt.

The reason they use FCF/EV is that, based on 1991-2018 data from the Russell 1000, this valuation metric is strongly correlated with annualized returns:

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In this data set, they found that FCF/EV had superior absolute and risk-adjusted returns compared to other metrics like FCF/Price, P/E ratios, P/B ratios, or dividend yield. Whether this correlation will work in the future or not is up in the air, but 17 years of this data, and nearly a century of other value data, puts the odds in its favor.

There is no shortage of various value-weighted schemes for U.S. equities, but what caught my eye about this set of ETFs was its global focus. An ETF that holds only non-financial stocks, for example, might be of use in an otherwise cheap market like Europe that has negative bond yields, which are killing banks and insurers.

Global Cash Cows Dividend ETF (ticker: GCOW)

This was Pacer’s original Cash Cow Series ETF. It invests in the top 100 non-financial companies in developed markets in terms of FCF/EV and high dividend yields. It’s an interesting choice for anyone that wants to hold a fund that follows value and high dividends throughout the developed world, regardless of which country it might be found.

It is heavily concentrated in the energy, communications, and materials sectors, so I advise caution with this one. If you expect a large bull market in commodities, this may be a winner, but if the commodity bear market persists, this one could continue to struggle.

Pacer US Cash Cows 100 ETF (ticker: COWZ)

This one has no dividend requirement, and just invests in the top 100 non-financial companies in the U.S. based on FCF/EV, and is very interesting at the moment. A quarter of the fund is in beaten-up technology names like Micron and Lam Research. Another quarter is in healthcare, which I have mixed views on. The rest is rather diversified between the remaining sectors.

Since its inception in late 2016, it has mildly outperformed the Russell 1000 Value index but has underperformed the broader Russell 1000 index.

Pacer US Small Cap Cash Cows 100 ETF (ticker: CALF)

This fund, which gets bonus points for the great ticker, focuses on the top 100 non-financial small cap companies in terms of FCF/EV. Right now, it has over a quarter invested in beaten-down small industrials, another quarter in consumer discretionary, and a little less than a quarter in technology. The final quarter is diversified among the rest.

Pacer US Cash Cows Growth ETF (ticker: BUL)

This fund, also with a great ticker, starts with the S&P 900 Pure Growth index, and then only invests in the top 50 non-financial in terms of FCF/EV. This results in a “growth at a reasonable price” fund, with companies like Alphabet, Twitter, Paypal, and Cisco. Technology makes up 40% of the fund.

Pacer Developed Markets International Cash Cows 100 ETF (ticker: ICOW)

This was the ETF that drew my attention first, because it invests throughout beaten-down Japan and Europe without exposure to financials in their zero/negative interest rate environment.

This one is broadly diversified, with consumer discretionary being the largest sector at about one-fifth of the fund. The other sectors are pretty spread out.

Since growth stocks have broadly outperformed value stocks over the past several years, leading to one of the largest divergences in the past fifty years, most of these Cash Cow ETFs have underperformed since their inception a few short years ago. This fund, however, is one of the few that outperformed its benchmark, likely thanks to its exclusion of financials.

Investors that want developed ex-US exposure but without financials might do well to consider this one.

Pacer Emerging Markets Cash Cows 100 ETF (ticker: ECOW)

This one, as you might guess, invests in non-financial emerging market stocks with good FCF/EV ratios. Many emerging markets have a big weighting in financials, and this eliminates that.

However, the sectors in this fund are concentrated in materials, energy, and communications, so it’s worthy of caution if you’re not a big commodity bull.

Pacer Cash Cows Fund of Funds ETF (ticker: HERD)

With one of the most creative tickers in ETF history, this ETF holds five Cash Cow ETFs at a 20% weighting each. The results is 60%+ in U.S. stocks (including the full index, small caps, and a growth tilt), and a little less than 40% in foreign developed stocks. The one ETF it excludes is emerging markets.   

Final Thoughts

Creative funds like these are giving investors more and more potential filters to access specific types of companies, which can be particularly useful when trying to navigate international exposure.

The ICOW ETF is probably the most interesting in my view, because the financial sector has been my biggest concern with the ex-US developed world for the past few years. This vehicle provides a potential way to gain that exposure for those that want it without the bank and insurance companies in those regions. 

However, caution is warranted. Quantitative strategies like this have popped up in the past decade from various firms, and so far most of them have underperformed. We happen to be in a 12-year period where the growth factor has outpaced the value factor globally, although higher-quality value strategies like the ROIC + value strategy have held up well.

I personally like to pick stocks individually when possible because I’ve generally found that a combined quantitative and qualitative analysis approach (which takes into account both past data and future expectations) works better than a purely backward-looking quantitative approach.

These types of strategies may be ideal for some investors, but I find them valuable mainly for research purposes rather than as actual investing vehicles. You can look through their holdings for stock ideas, kind of like using a stock screener to filter for certain criteria. You can keep tabs on the performance of various methodologies to see how well each methodology is holding up over time, what their research basis is, and how sectors may be playing a role.

Lyn Alden Schwartzer covers North American stocks and international equity ETFs with a focus on fundamental valuation. Her background is a blend of engineering and finance, and she uses a dispassionate long-term quantitative and qualitative approach to filter through the noise and find value in stocks and markets around the world.
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