COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (2024)

COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (1)

For those investors who like to march to the beat of their drum and don't care about what the market or magnificent seven are doing, old-school Buffett-style deep value investing is the most powerful strategy you can use.

Warren Buffett's favorite valuation metric is free cash flow yield, specifically free cash flow/enterprise value (factors in debt).

This is as pure a value investing as you can achieve, and it's also the best-performing value strategy of the last 30 years.

Thus far, Pacer US Cash Cows 100 ETF (COWZ) has been the king of this style of exchange-traded fund, or ETF, investing.

There is one potential better strategy than pure FCF/EV yield: VFLO's screen for FCF/EV with the weakest 33% of slow-growers screened out.

  • COWZ Vs. VFLO: We Might Have A New King Of Buffett-Style ETFs.

This creates the ultimate potential Super GARP ETF, combining history's best valuation metric with superior growth.

I plan to buy some VictoryShares Free Cash Flow ETF (VFLO) alongside COWZ when I can (my family is facing seven major financial/medical crises right now) because I believe VFLO's underlying strategy is that promising.

However, I must continue challenging COWZ as the current default king of Buffett-style (deep value free cash flow yield) ETFs for one simple reason.

VFLO's potential superiority over COWZ relies on whether or not its proprietary long-term growth model is accurate.

There is a chance that VFLO's model isn't that good, and it's being "too cute" with an otherwise bulletproof strategy.

Thus far, VFLO has tripled the returns of value stocks and quadrupled tech stocks. But COWZ has left everyone else in the dust, as you'd expect to happen based on history.

Value is the 3rd most undervalued compared to growth right now. The only two times that value was even more undervalued were 2000, the height of the tech bubble, and 1929, just before the 87% stock market crash.

In both periods, value went on a 7 to 13-year mega-rally that made the careers of legendary value investors like Ben Graham and Bill Miller.

This Is Potentially Why COWZ Is Kicking Butt

State Of The Economy Annual Return Advantage Value Overvalued Annual Return Advantage Value Undervalued

Annual Return Advantage Value Trading Historical Return

Expansion -7% 1% 0%
Slowdown -16% 5% -1%
Contraction -4% 0% -2%
Recovery 1% 4% 3%

(Source: Vanguard.)

Normally, value outperforms growth only in an economic recovery.

Unless value is dirt cheap, the economy's slowdown is the best time to buy these companies.

Guess when the economy tends to slow in a Fed rate hike? 15 to 18 months after the Fed's first rate hike.

That would mean you'd predict, based on how cheap value stocks are and the historical economic rate hike cycle, that between June and September 2023 is when value stocks would start to shine.

History doesn't always repeat, but it tends to rhyme." - Mark Twain.

OK, so COWZ looks like it is the new hotness and might have ways to run.

But is it truly the best Buffett-style free cash flow ("FCF") yield-based deep value ETF? Well, that's what I'm on a mission to find out.

Because Pacer, the company behind COWZ, has an entire family of ETFs that uses this strategy or some version of it.

So join me in comparing COWZ to one of its smaller Pacer rivals, Pacer US Small Cap Cash Cows 100 ETF (CALF).

What is the promise of CALF?

If deep value is likely to crush the market in the coming years, then why not get the best deal possible? If COWZ can do deep value with big companies this well, then maybe using small caps that are much cheaper can result in even better returns.

Throw in the fact that small caps tend to be faster growing, and you might potentially have an ETF that could give even VFLO's theoretical 17% long-term returns a run for their money.

But before we get too excited about CALF's potential, let's look at the actual facts.

Why COWZ Is Still The King Of Buffett-Style Deep Value ETFs

Buffett calls free cash flow "owner earnings" and considers it the purest form of intrinsic value.

  • free cash flow is the money left over after running the business and investing in all future growth
  • the "free" money the owner can spend sustainably
  • what pays for dividends and buybacks.

We've already seen how FCF/EV is the best-performing value metric.

16% average annual returns compared to 12% for the S&P 500 over 33 years.

Those 33 years included a decade when growth crushed value then a decade when value crushed growth. And then another decade of growth crushing value.

So you can see how I would be impressed with an investing strategy that beat the S&P 500's 12% average annual return and the Russell 1000's 9.5%.

What makes COWZ special is that it uses what might be the optimal strategy for large-cap deep value.

It starts with the 1000 biggest U.S. companies and then sorts by FCF/EV.

It then takes the 100 top FCF yield companies based on the last year.

It then weights by FCF yield with a risk cap of 2%.

This strategy has natural weaknesses, especially the backward-looking FCF yield strategy. Then again, trailing FCF yield is far less speculative than trying to forecast future cash flows.

COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (9)

Why is COWZ crushing it so much? Because it's priced for a severe recession already. Including a 14% to 27% decline in fundamentals. It's a low bar to clear for COWZ, while the Nasdaq is priced as if God were running the Magnificent 7.

At the start of July, the new COWZ quarterly portfolio had an FCF/EV yield of almost 10% and a P/E of 6.6.

How incredible is a P/E of 6.6 for a portfolio of large U.S. companies?

Private equity is seeking 12% to 20% long-term returns, and they are paying 12X earnings right now.

Mark Cuban, the billionaire king of Shark Tank, is paying 7X earnings, the ultimate sweetheart deals.

Imagine a 100-stock diversified portfolio of companies trading at a better valuation than Mark Cuban can get today!

According to Morningstar's estimates, COWZ is now up to 10X earnings, offering as much as 22% annual long-term return potential.

  • for this exact portfolio
  • Within a year, the entire portfolio will have changed.

COWZ is not a diverse portfolio in terms of sector. If that's where the value is, it will go heavy into cyclical-like energy.

Even though energy doesn't happen to be moaty, COWZ can deliver a relatively wide moat portfolio of high-quality companies with 19% returns on capital.

You can see how it's mostly big oil companies driving the current rally, and in fact, all of these companies will be rebalanced back to their 2% risk caps.

That means profit-taking in a highly cyclical sector.

Now I know what you're thinking: a 90% turnover rate is very high. And if the average annual gain is 16%, then capital gains taxes could be a big hit to returns.

Since its inception, COWZ has given up 0.73% of its annual returns to taxes, or 5% of gains.

ETF Tax Expense Ratio Since Inception Annual Total Returns Since Inception

% Of Gains Given Up to Taxes

JEPI (Covered Calls) 3.86% 8.29% 46.6%
AMFAX (Managed Futures) 1.79% 5.04% 35.5%
IEF (Bonds) 1% 3.43% 29.2%
SYLD 1.08% 12.44% 8.7%
SCHD 0.94% 13% 7.2%
VIG 0.57% 9.22% 6.2%
SPY (S&P 500) 0.59% 9.91% 6.0%
COWZ 0.73% 13.44% 5.4%
CALF 0.51% 10.62% 4.8%
MOAT 0.51% 14.23% 3.6%
QQQ 0.22% 9.20% 2.4%
SCHG 0.31% 15.12% 2.1%

(Source: Morningstar.)

When high turnover ETFs are run well, using tax loss harvesting, the tax efficiency can be superior to that of the S&P 500.

Why Calf Is A Worthy Challenger

COWZ is rated 5-star silver by Morningstar, meaning its historical returns are in the top 10% of its peers (top 1%) over the last 3 years. Morningstar is confident it will outperform in the future due to its superior strategy.

CALF scores a silver rating, too, though it hasn't been as successful in terms of historical returns.

CALF is in the top 22% of peers in the last three years, though its tax-adjusted 5-year percentile is 93rd. That means out of 420 small-cap value ETFs, it was in the top 21.

So, what is the awesome strategy generating such remarkably consistent peer-crushing returns?

Start with the S&P 600 small cap index, then sort by FCF/EV and select the top 100 companies, weighted by FCF yield. And use 2% risk caps.

This is the exact formula for COWZ, just with 600 smaller companies.

COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (17)

Three of the S&P 600 top 10 are dividend champions, and RLI is three years from becoming a dividend king. Glacier Bancorp hasn't cut its dividend in 30 years.

These are some truly high-quality small-cap companies.

Note that the ultimate FCF yield for CALF was 5% higher than COWZ at the end of June.

Even today, Morningstar estimates CALF's P/E at an impressive 8.9, with a price-to-operating cash flow of just 3.

This is some high-quality small-cap deep value, to be sure.

But notice something. Morningstar's analysts' long-term earnings growth forecast is just 9%, about half that of COWZ.

What gives? Aren't small caps supposed to be fast-growing? The issue is the S&P 600 small-cap index.

Those small-cap regional banks, all those dividend champions? Well, they aren't particularly fast-growing.

  • RLI has a 47-year dividend growth streak but has been growing at 5% annually for the last five years.

The S&P 600 index is designed to focus on quality over growth rates.

COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (19)

In 2024 and 2025, COWZ is expected to grow about 2X as fast as CALF, despite being made up of much larger companies.

And that means you can sometimes buy some high-quality aristocrats at valuations that make COWZ look expensive. But you won't necessarily outperform COWZ.

You won't find many wide moats in the small-cap universe. However, the profitability of these small caps is pretty impressive at 18% returns on capital, close to 20% of COWZ.

The sector concentration is much lower, with just 50% being energy or consumer cyclical.

The high turnover of CALF might explain why it is in the top 7% of small-cap value funds.

What happens if a small cap takes off? It becomes a mid-cap, and the small-cap ETF has to sell it.

Most of these small caps (S&P 600) are slower growing, so not many fall out of the index each year.

The best way for companies with 12% to 13% long-term return potential to outperform is when they go from undervalued to overvalued and get rebalanced quarterly by CALF's algos.

Do The CALF Facts Live Up To The Hype?

Total Returns Since 2017

What amazed me about COWZ is that it beat the S&P 500 when growth was driving all the S&P's returns, and almost no value ETF could even come close to keeping up with the market.

CALF managed to run circles around small cap value but couldn't come close to matching COWZ.

In terms of average annual returns, CALF beat the market; in fact, small-cap value kept up with the S&P over the last six years.

But regardless of the time frame, COWZ remains the standard value ETF.

Its worst 5-year return was double-digit gains, which is superior to CALF and small-cap value, and even the S&P 500.

Bottom Line: Long Live COWZ: Still The King Of Buffett-Style Deep Value ETFs

CALF is a great small-cap ETF. So far, it's the best small-cap ETF I've ever seen. Its focus on deep value FCF yield has made it one of the few small-cap funds that could match the market's average returns over the last six years.

CALF focuses on high-quality small caps and uses the most proven valuation methodology. It's historically in the top 7% of its peers, and I expect it will keep proving itself over time.

In recent months, CALF has beaten VFLO, proving the price of Buffett-style deep value ETFs.

But I don't see why someone should necessarily buy CALF for their portfolio, given that its design is unlikely to yield superior returns to COWZ.

The S&P 600 isn't built to beat COWZ. It is designed to beat the S&P 500 (12% long-term returns vs. 10%), but COWZ is in a league of its own.

While there are many potentially attractive challenges to COWZ's deep value Buffett-style ETF throne, none can yet unseat the king.

If you want to invest as Buffett did in the 1950s through the 1970s, COWZ remains the gold standard ETF.


COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (25)

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Greetings, fellow investors and enthusiasts! As someone deeply entrenched in the world of value investing and ETF strategies, allow me to dive into the intricacies of the article you've presented. My comprehensive knowledge and experience in the field will shed light on the concepts discussed and help you navigate through the nuances of these investment strategies.

Firstly, the article emphasizes the prominence of old-school Buffett-style deep value investing, specifically highlighting Warren Buffett's preference for the free cash flow yield metric, calculated as free cash flow divided by enterprise value. This metric, which factors in debt, is touted as a pure form of value investing and has been the best-performing value strategy over the past three decades.

The primary focus revolves around two ETFs: Pacer US Cash Cows 100 ETF (COWZ) and VictoryShares Free Cash Flow ETF (VFLO). COWZ is lauded as the king of Buffett-style ETFs, utilizing the FCF/EV yield strategy with an impressive historical performance. VFLO, however, introduces a potential improvement by screening out the weakest 33% of slow-growers, creating what the author calls the ultimate Super GARP (Growth at a Reasonable Price) ETF.

The article raises questions about VFLO's potential superiority over COWZ, particularly concerning the accuracy of VFLO's proprietary long-term growth model. Despite VFLO's remarkable performance, there's a cautious approach, suggesting that the strategy might be overly optimistic.

An interesting perspective is introduced regarding the economic cycle and the historical advantage of value over growth during economic recoveries. The timing is correlated with the Federal Reserve's rate hike, indicating a potential opportunity for value stocks between June and September 2023.

Now, let's delve into the specifics of COWZ's strategy. It begins with the 1000 biggest U.S. companies, sorting them by FCF/EV and selecting the top 100 based on the last year's FCF yield. The portfolio is then weighted by FCF yield with a risk cap of 2%. COWZ is portrayed as being priced for a severe recession, with a significant decline in fundamentals, making it an attractive option.

The article further discusses the tax efficiency of COWZ, highlighting its performance in terms of annual total returns and the percentage of gains given up to taxes since inception. It compares favorably with other ETFs, showcasing its effectiveness in managing tax implications.

The challenger to COWZ's throne is Pacer US Small Cap Cash Cows 100 ETF (CALF). The promise of CALF lies in its utilization of the same FCF/EV yield strategy but with 600 smaller companies. The argument is made that if deep value works well with big companies in COWZ, perhaps using smaller caps in CALF could yield even better returns, considering their potentially faster growth.

CALF's strategy involves sorting the S&P 600 small-cap index by FCF/EV, selecting the top 100 companies, and weighting them by FCF yield with a 2% risk cap. The article acknowledges the high quality of small-cap companies in CALF but questions its potential for outperforming COWZ due to a lower expected long-term earnings growth forecast.

In terms of performance, CALF is praised as an excellent small-cap ETF, consistently outperforming its peers and even beating VFLO in recent months. However, the author remains skeptical about CALF's ability to surpass COWZ in terms of superior returns.

In conclusion, while CALF is recognized as a great small-cap ETF, the article maintains that COWZ remains the gold standard ETF for those seeking to invest in the Buffett-style deep value strategy. The intrinsic qualities of COWZ, including its historical performance, tax efficiency, and large-cap focus, position it as the reigning king in this particular investment niche.

COWZ Vs. CALF: One Is The King Of Buffett-Style ETFs (2024)


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