GCOW: Strong Value ETF, Diversified Holdings, Cheap Valuation, 3.2% Yield (BATS:GCOW)

About one month ago I wrote about the Pacer US Cash Cows 100 ETF (COWZ), a value ETF focusing on U.S. companies with strong cash-flow yields, or cash cows. COWZ is a strong value ETF, and has outperformed YTD, as valuations normalize. COWZ exclusively invests in U.S. companies, but Pacer ETFs has a similar fund for global companies, the Pacer Global Cash Cows Dividend ETF (BATS:GCOW). GCOW’s diversified holdings, cheap valuation, and above-average 3.2% dividend yield, make the fund a buy.

GCOW – Overview

GCOW is an equity index ETF. The fund follows a simple 3-step process to create its stock portfolio. It first screens companies in a global large-cap index for free cash flow yield, then screens for dividend yield, and then weights them by dividend yield. Weights are capped to ensure a modicum of diversification. The fund has several other inclusion criteria, centered on liquidity, size, etc., criteria, but nothing particularly impactful. GCOW has a handy infographic explaining their portfolio construction process.

GCOW is a reasonably well-diversified fund, with investments in 100 different companies, over a dozen countries, and all relevant industry segments. Country weights are as follows.

As can be seen above, the fund invests in several countries. Global equity funds tend to focus on U.S. equities, due to the size and strength of the country’s economy and public equity markets, and GCOW is no exception, with a large 32% allocation to U.S. equities. On the other hand, most global equity funds have higher U.S. allocations, usually more than half. GCOW is also overweight the United Kingdom and Japan, in part because these are relatively large countries, and in part because both sport relatively cheap valuations / high yields.

Industry-wise, the fund is significantly overweight materials and energy, due to their comparatively cheap valuations, strong yields, and strong generation of cash. On the flipside, the fund is significantly underweight tech, for the opposite reasons. Industry allocations are as follows.

Concentration is about average for a diversified equity fund, with the fund’s top ten holdings accounting for just 23.5% of its value. GCOW’s largest holdings are heavily weighted towards energy stocks, as weights are dependent on yields, and energy stocks offer comparatively high yields.

GCOW’s diversified holdings are a benefit for the fund and its shareholders, reduce risk and volatility, and significantly reduce the possibility of sizable losses due to idiosyncratic factors or events. On the other hand, the fund is somewhat less diversified than the average global equity index fund, and with divergent industry weights.

GCOW focuses on companies with above-average free cash flow and dividend yields. The fund itself has a free cash flow yield of 7.9%, more than twice as high as the 3.4% for the FTSE Developed Large-Cap index. The fund’s 3.2% yield is also significantly higher than the 2.0% global equity average. Focusing on companies with above-average yields means, in practice, focusing on companies with cheap valuations, as yields are a relatively common valuation metric. Due to this, the fund sports a relatively low 11.8x PE ratio, less than half that of its index, with a 25.5x ratio.

GCOW’s cheap valuation is the fund’s most important characteristic and core investment thesis and provides investors with three important benefits.

First, cheap valuations could lead to strong, market-beating returns, assuming market sentiment improves and valuations normalize. Sentiment has been improving for months now, with the fund significantly outperforming U.S. and global equity indexes YTD. Outperformance was due to improved market sentiment, especially for undervalued sectors and stocks, buoyed by rising commodity prices, inflation fears, the prospect of higher interest rates, and geopolitical risks.

GCOW’s overweight energy position has been particularly beneficial these past few months, as skyrocketing energy prices have led to significant energy industry outperformance. The fund’s overweight materials position was also beneficial, as said sector has also outperformed, but only slightly so.

GCOW has also outperformed during the past twelve months or so, but all gains have occurred since December 2021.

Valuations are strongly dependent on investor sentiment, which seems broadly positive about value stocks and old-economy industries, over growth stocks and tech. Above-average inflation rates and commodity prices are benefiting materials and energy, while higher interest rates are hurting more speculative, long-term tech plays. Growth remains about 40% overvalued relative to their historical average and has underperformed for months. Under these conditions, growth will likely continue to underperform, while value will likely continue to outperform, in my opinion at least.

On a more negative note, a large reason for expensive growth valuations / cheap value valuations is consistent growth outperformance / value underperformance. Value stocks are cheap because their share prices have stagnated for years, meaning little in capital gains for their shareholders. Growth stocks are expensive because their share prices have skyrocketed for years, meaning significant gains for their shareholders. Value stocks and funds have underperformed for years under these conditions, and that includes GCOW.

Second benefit from the fund’s cheap valuation, is the fact that these serve to reduce the possibility of significant losses, at least under current market conditions. Stocks trading with 100x PE ratios can drop a lot more than stocks with 10x ratios, as has happened these past few months. This is particularly the case for cheaply valued stocks with strong financials, which brings me to my next point.

GCOW’s cheap valuation helps make fund returns less dependent on fickle market sentiment. Companies with strong cash-flow yields can always choose to distribute said cash to shareholders, as either dividends or share buybacks. Both of these, especially dividends, boost returns, and are not dependent on investor sentiment to do so. GCOW’s underlying holdings generate 7.9% in free cash flow per yield, quite a bit higher than the global equity average of 3.4%. GCOW’s underlying holdings could choose to distribute said cash to shareholders, leading to 7.9% in total shareholder returns, plus or minus capital gains from valuations increasing / decreasing. These are reasonably strong returns, ensure a modicum of gains even if sentiment turns bearish, and also helps reduce the possibility of significant losses. Cash-flows put a floor on a company’s valuation, as companies with significant cash-flows can always choose to massively increase their dividends or share buybacks plans, and investors know that, so share prices can only drop so much. This is most definitely not the case for companies with little cash-flow yields, which can exhibit greater losses as a result.

GCOW’s strong free cash flow yield is the fund’s most important benefit, and core investment thesis.

Quick COWZ Comparison

Finally, a quick comparison between GCOW and its peer fund, COWZ.

Both funds focus on companies with comparatively strong free cash-flow yields, and sport comparatively cheap valuations as a result.

GCOW invests in U.S. and international companies, while COWZ only invests in U.S. companies.

GCOW’s dividend yield screens are a bit stronger, and so the fund yields a bit more than COWZ. On the flipside, COWZ’s cash-flow screens are a bit tougher, and so the fund’s valuation metrics are generally stronger. A quick table of these metrics.

GCOW has significantly underperformed relative to COWZ since inception, as international / global equities have underperformed relative to U.S. for the same.

On a more positive note, GCOW’s performance has materially improved these past few months, as investors rotate into value / underperforming stocks. GCOW has outperformed COWZ for the past six months, but performance is spotty and volatile, so I wouldn’t put too much emphasis on the outperformance itself.

GCOW’s most significant benefit relative to COWZ is its greater diversification. COWZ’s most significant benefit its cheaper valuation. Both are good choices, and quite similar regardless.

Conclusion

GCOW focuses on global equities with above-average cash-flow and dividend yields. The fund could outperform if valuations normalize, as has been the case the past few months. GCOW is a buy, and particularly appropriate for investors looking for value funds.