The Pacer US Small Cap Cash Cows 100 ETF (BATS:CALF) places a unique focus on small-cap stocks with high free cash flow yields. We’ll delve into the specifics of its strategy and holdings in this article, but one thing that immediately jumps out about this ETF is its outstanding performance over the past several years. For the quarter that ended on March 31st, CALF has returned a phenomenal 31.5% annually over the previous three years. Let’s take a look at the specifics and discuss why CALF could be a good addition to your portfolio.
Cash is King
CALF is a $2.1 billion ETF from Pacer. You may be familiar with a similar, larger ETF from Pacer called the Pacer US Cash Cows 100 ETF (BATS:COWZ), which we recently covered. Both funds focus their investment strategies on stocks with high free cash flow yields. To put it simply, free cash flow is the cash that a company has left over after it pays for its expenses, interest, taxes, and long-term investments. This cash can then be used to create shareholder value by being used for share repurchases, dividends, acquisitions, or investing in new growth areas.
Pacer defines free cash flow yield as a company’s free cash flow divided by its enterprise value (market cap + debt – cash). Unlike other valuation metrics, the higher the FCF yield, the better. Pacer believes that focusing on free cash flow yield indicates “whether a company is producing more cash than it needs to run its businesses, therefore allowing for growth opportunities through other investments.” It also says that these companies are more likely to survive challenging economic times.
CALF is in good company in this regard — legendary investors ranging from Warren Buffett and Charlie Munger to Joel Greenblatt have all espoused the value of focusing on free cash flow. These investors feel that free cash flow paints a more accurate picture of a company’s financial health because management teams can make many adjustments to a company’s earnings with things like amortization and depreciation, but it’s harder to do this with cash flow. That’s why economist Alfred Rappaport, the author of Creating Shareholder Value, tells investors to “Remember cash is a fact, profit is an opinion.”
The key difference between CALF and COWZ is that while COWZ invests in the 100 stocks with the highest free cash flow yields in the Russell 1000 index, CALF specifically targets small-cap stocks with high strong free cash flow yields by investing in the highest 100 FCF-yielding stocks in the S&P Small Cap 600 Index.
Go Small or Go Home
Why focus on small-cap stocks? Pacer believes that investing in small caps is advantageous because these companies often offer higher growth potential than more established large-cap stocks. Furthermore, these companies are often underfollowed by Wall Street, meaning those who focus on them can theoretically gain an edge and take advantage of market inefficiencies when investing.
You can’t really argue with the results of this strategy thus far, as CALF has returned 31.5% on an annualized basis over the past three years, easily surpassing the total returns of the S&P 500 and NASDAQ over the same time frame.
Is CALF Stock a Buy, According to Analysts?
Wall Street analysts are not quite as bullish on CALF as I am — CALF has a consensus Hold rating from analysts. However, despite this Hold rating, the average CALF stock price target of $46.43 still represents ~24% upside potential, so analysts still see the value of CALF.
Of the 304 analyst ratings on CALF, 55.59% are Buys, 38.16% are Holds, and 6.25% are Sells.
CALF’s Holdings
CALF is a diversified ETF with 101 positions. Because it caps each investment at 2% of assets, CALF’s top 10 holdings make up just 20.9% of the fund, adding to this strong diversification. In case you are wondering why this number can be more than 20% given the 2% cap on each position, it’s because some holdings outperform others and thus account for a larger percentage of the fund until it periodically rebalances.
If you are like me, you may not be familiar with many of CALF’s top holdings. Because of its small-cap focus, this isn’t the typical fund that invests in blue-chip stocks and calls it a day — CALF goes deep into less covered parts of the market to find its holdings.
Below, you’ll find an overview of CALF’s top 10 holdings using TipRanks’ holdings tool.
The top holdings are a bit of a mixed bag, according to TipRanks’ Smart Score system. While stocks like Civitas Resources, LCI Industries, SM Energy, and Warrior Met Coal all have Smart Scores of 8 out of 10 or better (equivalent to an Outperform rating), one area for concern is that Signet Jewelers and Boise Cascade Company screen negatively with poor Smart Scores of 3 and 1 out of 10, respectively (equivalent to an Underperform rating).
The Smart Score is TipRanks’ proprietary quantitative stock scoring system that evaluates stocks on eight different market factors. The result is data-driven and does not require any human intervention.
CALF is fairly well-diversified across sectors. One interesting thing to note is that while COWZ is dominated by energy and healthcare names (energy has a massive ~36% weighting, and healthcare has a nearly 19% weighting), CALF’s largest exposure is to the consumer discretionary sector, with a 29.8% weighting. Industrials are the second-largest weighting at 19.3%, followed by energy at 17.2% and information technology at 11.1%. All other sectors have single-digit weightings.
Relatively High Fees
The only other minor drawback I would point out is that CALF’s expense ratio of 0.59% is a bit high (and higher than COWZ’s expense ratio of 0.49%), but this is a fund that runs a complex strategy and rebalances frequently, so it is not going to be as inexpensive as a basic S&P 500 fund, for example.
The CALF is Out of the Barn
CALF is building an outstanding track record with its 31.5% annualized gain over the past three years. Zooming out over a five-year time frame, its annualized return of 9.3% isn’t quite as impressive (and lags the S&P 500 and Nasdaq) but isn’t a poor performance by any stretch of the imagination.
My thought is that CALF, being a value-oriented fund, has unsurprisingly seen its three-year performance outpace the broader market (and its five-year performance) in an environment with macro challenges affecting high-multiple or unprofitable growth stocks. If we are in an environment where value stocks continue to outperform, then CALF could continue to outperform the broader market, going forward.
By screening for S&P SmallCap 600 Index companies and then further screening for just the top 100 of these companies by free cash flow yield, CALF has built a portfolio with an average price-to-earnings multiple of just 5.44 and a free cash flow yield of 14.1%, both of which are incredibly attractive from a value perspective.
Investing in stocks with these inexpensive valuations gives investors more margin of safety when investing and leaves room for upside. Overall, I am a fan of CALF and think that, in addition to COWZ, it’s a great ETF to consider building a portfolio around.
Disclosure
Source: https://finance.yahoo.com/news/small-win-big-small-cap-134406890.html