Following a year in which a rapid rise in interest rates caused stock and bond prices to tumble, investors are focusing on quality. One way to do this is to look at free cash flow — and doing so might make for better long-term returns for growth investors.
The Pacer U.S. Cash Cows 100 ETF has shined as the Federal Reserve has clamped down on excess liquidity by raising interest rates in an attempt to lower inflation. Sean O’Hara, president of Pacer ETF Distributors, discussed the exchange-traded fund’s approach to stock selection during an interview.
Let’s begin with four sets of total returns (with dividends reinvested) for the Cash Cows ETF against ETFs that track its benchmark, the Russell 1000 Value Index and the S&P 500
ETF Ticker 5 years through March 7 2023 through March 7 2022 5 years through 2021 Pacer U.S. Cash Cows 100 ETF 78% 3% 0% 113% iShares Russell 1000 Value ETF 40% 1% -8% 68% SPDR S&P 500 ETF Trust 59% 4% -18% 132% Source: FactSet
The Cash Cows ETF has been the best performer over the past five years. You can see that it held up very well during the bear market of 2022 — and that for the five years through 2021, when interest rates remained very low and liquidity was elevated, the fund outperformed the iShares Russell 1000 Value ETF but trailed the SPDR S&P 500 ETF Trust
Cash Cows has $12.9 billion in assets under management. That’s up from $2.6 billion a year ago.
O’Hara said that when the ETF was launched in 2016 and for several years after that, stock valuations relative to earnings were at very high levels. The idea for Cash Cows was to identify value stocks in a way better suited to the modern world.
Traditionally, stocks are placed in the “value” camp if they trade low relative to book value. But O’Hara and his colleagues at Pacer believe this measure doesn’t work very well, “because the vast majority of the stock market’s value today is based on intangible assets and not tangible assets,” he said.
He cited Google parent company Alphabet Inc. As an example: The company’s market value is “based on the fact that they dominated search and figured out how to dominate it. Those are intangibles,” he said.
The broad stock-market indexes are weighted by market capitalization, so the largest tech names dominated during the liquidity-driven bull market. And even today, the largest five companies held by the SPDR S&P 500 ETF Trust — Apple Inc. Microsoft Corp. Alphabet Inc., Amazon.Com Inc. And Nvidia Corp. — make up 20% of the portfolio.
“It makes sense, when you think about the change in the economy from manufacturing to consumption, technology, brands, the health-based economy — those things thrive on intangibles,” O’Hara said.
For Cash Cows, the rules-based stock-selection approach is based on trailing free-cash-flow yields. A company’s free cash flow is its remaining cash flow after capital expenditures. This is money that can be used to pay dividends, repurchase stock or expand organically or through acquisitions, or for other corporate purposes.
A company’s trailing free-cash-flow yield is the sum of its free cash flow per share for its past four reported quarters, divided by the current share price.
The Cash Cows portfolio is reconstituted and rebalanced every quarter. The screen begins with the full Russell 1000 Index of the largest companies publicly listed in the U.S. Then all financial stocks are removed, since free-cash-flow yields aren’t typically available for the industry. Then there is a forward screen to remove any company expected to post any quarterly net losses over the following two years.
The remaining stocks are then ranked by trailing free-cash-flow yield, and the top 100 make the final list. These are weighted by free-cash-flow yield, with a maximum weighting of 2% for any stock.
O’Hara said free-cash-flow yields can be “a great predictor of what is going on in an economic cycle.”
Even before large technology companies were signaling slower growth rates, the Cash Cows portfolio had been leaning away from tech stocks, while companies in the energy, industrial, materials and healthcare sectors had “rotated in,” he said.
In addition to identifying undervalued stocks and moving with broad economic trends, this type of stock screening can point to trouble ahead if a company’s free-cash-flow yield is declining or if analysts expect net losses ahead. For example, Cash Cows held shares of Intel Corp. From September 2020 until December 2021. Intel cut its dividend by 66% last month.
Here are the fund’s top 10 holdings as of March 8. Some have weightings above 2% because of share-price increases since the fund was last rebalanced in December.
Company Ticker % of portfolio net assets Meta Platforms Inc. Class A 3.1% Nucor Corp. 2.3% LyondellBasell Industries NV 2.3% Marathon Petroleum Corp. 2.3% Dow Inc. 2.2% Valero Energy Corp. 2.2% Exxon Mobil Corp. 2.1% PayPal Holdings Inc. 2.1% Cisco Systems Inc. 2.0% Altria Group Inc. 2.0% Source: Pacer ETFs
Click on the tickers for more about each company or ETF.
Read Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.
Pacer has also applied the Cash Cows strategy to other groups of stocks, including the Pacer U.S. Small Cap Cash Cows 100 ETF and the Pacer Global Cash Cows Dividend ETF
Don’t miss: 20 income-building stocks that the numbers say could become elite Dividend Aristocrats
Twisted Cow Distillery Opens In East Northport
Marketing campaigns by the liquor industry usually distill down to the same message — booze’s capacity for turning us into different people. Bacardi commands you to live like you mean it, Glenfiddich appeals to your independent spirit, Jameson champions an existence without fear. In the recent Belvedere spot, Daniel Craig sets himself free of James Bondage and becomes the real Daniel, a tank top-sporting party animal who shimmies like an aging Britney Spears backup dancer.
If John Pawluk’s life were a liquor commercial, it would no doubt begin in predawn darkness. When first we see him he’d be just another faceless type in a suit riding the 5:29 train from Huntington, or maybe we’d catch him on the 7:22 home, at the tail end of a five-hour mind-numbing daily commute, although one with compensations like Pawluk’s Wall Street accountant’s salary. But 25 years of that can really take a toll — close-up on the furrowed brow, the fatigue, the isolation, the never seeing his family. .
But one day he has an idea, an idea that just might let him live like he means it and be independent. It seems like a fantasy at first. He will ditch the commute, trade Wall Street for flannel shirts, be his own boss, grow out his beard and devote the balance of his years to making things he is proud of.
He will open a craft distillery, joining the ranks of a small but growing number of intrepid souls selling spirits made on Long Island.
TWISTED COW DISTILLERY
In November, Pawluk’s Twisted Cow Distillery burst to life out of a former five-and-dime in East Northport, an expansive facility that’s part-cocktail lounge and part-state-of-the-art spirits factory, each open to the other. There are no motivational taglines on display, no Daniel Craig gesticulating wildly over a colorless, tasteless spirit. There is only Pawluk, threatening to go on an endless tangent about extractors or centrifuges. And also his spirits, which are a revelation.
Consider Twisted Cow’s rye vodka. It’s creamy and complex, possessing flavors of malted grain that are delicate but linger, and a finish so soft and sweet it begs for poetry. It could claim a slogan like best-tasting if Grey Goose hadn’t ruined that one, it leaves you breathless in a way Smirnoff can only dream of, and it’s handcrafted in a way that Tito’s says it is but really isn’t. The price? $40 a bottle.
“When I told people that rye vodka would be my first spirit, they said that’s crazy,” laughed Pawluk, strolling past giant mash cookers and tanks. “Rye is a hard grain to work with. It’s very sticky and foamy, and foam is not what you want with a setup like mine.”
Twisted Cow Series 19 vodka. Credit: Yvonne Albinowski
Judging from a taste of just the second batch he'd ever made of the stuff, it seems incomprehensible that a man who’d only been distilling spirits for months had already come up with something that Big Alcohol hadn’t in 150 years: a clear spirit that didn’t taste like hand sanitizer in a fancy bottle. And to think that he did it with rye.
But rye is grown locally, and from the beginning, Pawluk was adamant about only using Long Island grains in his spirits, which is how he ended up connecting with Foster Farm on the East End. It too produces its own spirits, and Matt Beamer, who oversees Sagaponack Farm Distillery there, has become a friend and mentor. “The smile on his face when we did the soft opening here meant so much to me,” Pawluk recalled. “I was like a little kid who’d grown up and was being kicked out of the nest.”
Twisted Cow sometimes feels like an act of penance for Pawluk, 51, who grew up in Smithtown but for decades spent most of his waking hours in Manhattan. Asked to describe his rye vodka, he said, “It’s unique, it’s Long Island, it’s got salt air involved. It’s us. It’s our soul.” (There’s that poetry.)
VISITING THE DISTILLERY
The handsome tasting room's bar area encourages good times both raucous and intimate. The large, square-shaped bar is surrounded by chocolate leather bar stools, deep black couches, windows for glimpsing the other room’s spirits-making, and wood, wood, everywhere, all of it lit by soft pendant lamps Pawluk hung himself. Some nights, an acoustic guitarist or jazz saxophonist might drop by to further set the mood, a nice complement to the dynamic bar staff, whose twin passions are, like Pawluk's, engaging the local community and relentless experimentation.
Twisted Cow Distillery in East Northport. Credit: Yvonne Albinowski
Bottoms Up, one of Twisted Cow’s most popular cocktails ($16), is made with a potato-based spirit by Sagaponack that is aged in barrels like whiskey, and which somehow contributes notes of honeydew and cantaloupe to a drink that seems determined to redefine whiskey sours forever. Sagaponack’s rye whiskey, meanwhile, makes its appearance in Twisted Cow’s old fashioned ($16), as does one of Blondie’s Not So Simple Syrups, a line of mixers created by Christine Eifert during the pandemic. As it happens, she is one of the mixologists Pawluk hired to bartend and develop cocktails out of his spirits. The winter margarita includes a splash of red wine from Northport’s Del Vino Vineyards. They had already concocted a lemon drop popular enough for Pawluk to start bottling as Lemontude, using a neutral grain spirit he distills and hundreds of pounds of lemons hand-squeezed on the premises.
The Cold Fashioned with Sagaponack Farm Distillery Rye Whiskey, Blondie's Winter Spiced Syrup, and bitters at Twisted Cow Distillery in East Northport. Credit: Yvonne Albinowski
In the quest for ever more interesting beverages, it seems that no local business is safe, not the chocolatier across the parking lot, and not the apples at 120-year-old Richters Orchard just up the road. Pawluk recently bought 250 gallons of cider there, mulled it and added some house-distilled rum. The result was Twisted Richters Cider Pie ($35), which tastes like something straight out of grandma’s kitchen, if considerably more potent at 50 proof.
Pawluk was already intent on bottling that too, the just-finished label featuring a sepia-toned photo of the orchard at sunrise. “I wanted that history,” he said. “People don’t realize what we have here, that this is one of the most successful farming sections in the state. It’s incredibly good.”
By his own admission, he is not a cocktail person ( “I like my coffee black and my bourbon neat”), but thanks to his mixologists, Pawluk has come to appreciate them. “They’ve opened my eyes to flavor development, to the way cocktails are built out of layers of flavor.”
Indeed, he is perpetually in search of more layers, more richness, which makes Pawluk something of a paradox — a man whose idea of the simple life is to seek complexity everywhere. You see it in his vodkas, his cocktails, his wanting to be a distiller and barman at once. The goal seems to be a community that demands more out of its cocktails, more out of its spirits, more out of life. No matter how long you’ve settled for the two-dimensional, Pawluk seems to say, it’s always possible to have three, or maybe more.