Large-cap tech stocks are in the spotlight, but investors can also win with small-cap stocks, as evidenced by the Pacer US Small Cap Cash Cows 100 ETF (BATS: CALF).
The ETF has been a quiet success with investors, taking in record inflows in January 2024, which was remarkably its 46th straight month of inflows. According to Bloomberg Senior ETF analyst Eric Balchunas, no other small-cap ETF has taken in more money over the past 12 months. CALF is quickly becoming a major player in the world of ETFs, as it now has $8.7 billion in assets under management (AUM).
I’m bullish on this small-cap ETF based on its winning track record, its cheap holdings, and its unique strategy, which we’ll discuss in depth below.
What Is the CALF ETF Strategy?
According to the fund’s sponsor, Pacer, CALF “aims to provide capital appreciation over time by screening the S&P SmallCap 600 for the top 100 companies based on free cash flow performance.”
This focus on free cash flow and free cash flow yield makes CALF stand out from your average small-cap ETF.
Free cash flow is simply the cash the company has left over after paying expenses, interest, taxes and long-term investments. This cash can be used to create value for shareholders by doing share buybacks, paying dividends or even making acquisitions.
Free cash flow yield is derived by taking a company’s free cash flow per share and dividing it by its share price. In general, the higher the free cash flow yield, the more attractive the stock looks.
Pacer explained, “The ability to generate a high free cash flow yield indicates that a company is generating more cash than it needs to operate the business and can invest in growth opportunities.”
While Pacer has another fund focused on free cash flow performance called Pacer US Cash Cows 100 ETF (BATS: COWZ), an additional benefit of taking this strategy and focusing specifically on small-cap stocks is that it can offer “exposure to higher-growth companies that are often under-researched.” Pacer says this focus gives investors exposure to a part of the market where “high-quality stocks are trading at a discount.”
So how does CALF choose these high free cash flow stocks that it invests in? Let’s take a look at its investment process.
CALF investment process
CALF starts by looking at all 600 stocks in its investment universe, the S&P Smallcap 600 Index. It then examines these companies for the top 100 names based on their free cash flow performance over the trailing 12 months.
Screening for these top 100 companies creates a portfolio of holdings that is significantly cheaper, and that produces a much higher cash flow yield than the initial 600 stock universe. As of CALF’s last quarterly rebalancing, the 600 stocks in its initial investment universe had an average price-to-earnings multiple of 15.0 and an average free cash flow yield of 4.3%. But examining the top 100 stocks by free cash flow yield, this new list has an average price-to-earnings ratio of just 10.0 and a free cash flow yield of 13.2%.
CALF then tips the scales further toward value and higher free cash flow yield by weighting these 100 properties by cash flow, creating a final portfolio with a slightly lower average price-to-earnings ratio of 9.3 and a slightly higher free cash flow yield of 14.4 . %. Note that in order to maintain a well-rounded portfolio, CALF caps these positions at 2% when it rebalances each quarter.
What results does this complex investment process generate? It turns out that it has produced quite an impressive track record over time, as we will discuss in the next section.
How Does Calf Work?
Since the end of the most recent quarter, CALF has generated an annualized three-year return of 17.3% and an impressive five-year annualized return of 17.4%.
These are excellent returns that beat both its benchmark and the broader market over both time frames. For comparison, using the same time frame, CALF’s benchmark, the S&P SmallCap 600 Value Index, has returned 10.2% on an annualized basis over the past three years and 11.3% on an annualized basis over the past five years. These are solid returns, but CALF has outperformed them well over both time frames.
Similarly, as of the most recent quarter, the Vanguard S&P 500 ETF (NYSEARCA:WOO), a good proxy for the broader market, has returned 10.0% over the past three years and 15.7% over the past five years, meaning CALF has outperformed it over both time frames.
Balanced, Low cost portfolio
So, what does CALF’s portfolio look like? As mentioned above, CALF holds 100 stocks, and because it limits positions at 2% when it rebalances, its top 10 positions make up only 21.9% of assets. Below is an overview of CALF’s top 10 holdings using TipRanks holdings tool.
Although these are small-cap stocks that may not be familiar to many investors, the fund’s main holding, Abercrombie and Fitch (NYSE:ANF), demonstrates why its strategy of focusing on companies that produce high free cash flow returns can be effective. After being undervalued for a long time, Abercrombie and Fitch is up 300% over the past year.
The largest exposure of CALF is to the consumer free sector, with a weight of 37.3%. Its second largest exposure is to industrials, with a weight of 17.2%. While you won’t find some of the market’s hottest tech stocks in the fund, due to its small-cap focus, information technology is present here and has a weighting of 10.6%, the fund’s third largest sector. Finally, energy is the final sector with a double-digit weight of 10.5%.
What Is CALF’s Expense Ratio?
CALF’s expense ratio of 0.59% means an investor will pay $59 in fees on a $10,000 investment in CALF each year. While this is a bit high, CALF has produced excellent, market-leading results over a multi-year time frame, which means it’s probably worth it.
Is CALF Stock a Buy, According to Analysts?
Turning to Wall Street, CALF earns a Hold consensus based on 48 Buy, 44 Hold and 10 Sell ratings assigned in the past three months. The average CALF stock price target of $50.75 implies a 7.2% upside potential.
The Takeaway: A Different Way to Win
CALF is an excellent ETF that has used its unique strategy of focusing on small-cap stocks with high free cash flow yields to beat its benchmark and the broader market over the past three and five years.
I remain bullish on the ETF based on its unique and efficient investment process that has proven itself over time, the long-term track record it generates, and the attractive valuations of its holdings. While large-cap technology and growth stocks are deservedly in the market, CALF shows that there is more than one way for investors to win in the market.
Disclosure
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.