beckariuz Investment Thesis The Pacer US Small Cap Cash Cows 100 ETF (BATS:CALF) recently emerged as a top performer, outpacing 90% of its small-cap peers over the last six months. The portfolio changes I documented in September proved beneficial. And after the latest reconstitution, I’m now in a position to recommend CALF because of its low valuation, high free cash flow margins and profitability, and strong analyst momentum. I look forward to explaining why in further detail next. CALF Overview CALF tracks the Pacer US Small Cap Cash Cows Index, selecting 100 small-cap companies with high trailing twelve-month cash flow yields. Constituents are weighted based on free cash flow dollars rather than free cash flow yield, meaning larger companies are advantaged. It’s a simple but crucial distinction for small-cap companies especially. A free cash flow yield screen on small-cap stocks typically results in an overly risky portfolio. The graphic below describes the selection process, which includes a 2% weighting on individual securities. The quarterly reconstitutions allow for less style drift, but frequent turnover is only sometimes advisable with deep-value stocks. In September, CALF had the twelfth-worst YTD returns in a peer group of 72, but it closed the back half of the year with the seventh-best returns. Conservative investors may frown on these ups and downs, whereas risk-takers see opportunity in each reconstitution. Pacer ETFs This graphic also highlights the pitfalls of investing in standard small-cap Indexes. For example, the free cash flow yield posted for the S&P SmallCap 600 Index is -9.79%, suggesting poor quality. CALF’s 13.53% figure, if nothing else, improves the chances that its selections are at least profitable. In my opinion, the screen is less valuable with large-cap ETFs like the Pacer US Cash Cows 100 ETF (COWZ). CALF’s expense ratio is 0.49%, so it’s costly. However, I noted in my annual U.S. Equity ETF review that the small-cap segment is one where investors should consider higher-fee products. If a strategy is that much better, it’s worth the money. Sector Exposures and Top Ten Holdings CALF is a very concentrated ETF with nearly 50% of its holdings in Consumer Discretionary and Industrials stocks. There’s no exposure to Financials, Real Estate, or Utilities, and only 3.59% to Consumer Staples. This composition indicates high volatility, so it’s most appropriate for risk-takers who view volatility as an opportunity. Morningstar Due to the mostly equal-weight nature, CALF’s top ten holdings list isn’t representative of the ETF. However, recent top performers include Signet Jewelers (SIG), Matson (MATX), and UFP Industries (UFPI). These aren’t household names, but I will add more color soon by examining the fund at the industry level. Pacer ETFs Performance History The following table summarizes 1-5 year returns for the 30 largest small-cap dividend, value, and blended ETFs with sufficient history. The list is sorted by five-year returns, and CALF’s 44.41% gain was fourth-best behind RWJ, XSVM, and DWAS. The Sunday Investor Last year’s 15.20% loss was mediocre, only the 17th best in this sample. However, as discussed previously, its six-month returns to finish the year were seventh-best in total and third-best in this sample, behind DWAS and VBR. Added volatility is apparent when looking at long-term returns. Still, CALF’s annualized standard deviation is similar to the iShares S&P SmallCap 600 Value ETF (IJS) and the iShares Core S&P SmallCap ETF (IJR). CALF’s 7.68% annualized return mostly offset the higher risk, leading to competitive Sharpe and Sortino Ratios. Portfolio Visualizer CALF Analysis The last reconstitution swapped 27 companies, and I favor several changes. Oil & Gas E&P representation increased by about 2% to 6.70%, followed by Automotive Retail (6.19%), Semiconductors (4.74%), and Biotechnology (4.66%). Meanwhile, CALF reduced exposure to the riskier Apparel Retail industry, which now accounts for just 3.05% of the portfolio. The results are stronger fundamentals, so I believe CALF is moving in the right direction. The following table summarizes several metrics, both pre-and post-reconstitution, and the bottom rows allow you to compare against IJS and IJR for benchmark purposes. The Sunday Investor What makes CALF unique is its 8.03/10 Profit Score, derived using Seeking Alpha Factor Grades and the highest among all 75 small-cap ETFs I track. The previous portfolio scored a respectable 7.77/10, and both easily beat the 5.53/10 and 6.02/10 scores for IJS and IJR. Other quality-focused small-cap ETFs like KSCD, DGRS, SQLV, OUSM, and XSHQ have scores between 5.22/10 and 7.62. However, only some can match CALF’s estimated 21.12% earnings growth rate and 13.66% free cash flow margins, and none can match its 8.67x forward earnings valuation. The 6.47x trailing cash flow valuation is further evidence that the current portfolio represents high quality at a low price, an approach I recommend when dealing with the small-cap segment. Finally, I want to highlight CALF’s improved 5.96/10 EPS Revision Score. Typically, value-oriented portfolios rotate into beaten-down stocks with each reconstitution, but this score proves that CALF works differently. Many top holdings had positive sales and earnings surprises last quarter. They also have double-digit expected sales growth, trade below 10x forward earnings, and have B+ or better Seeking Alpha EPS Revision Grades. Here are six examples. Seeking Alpha Investment Recommendation CALF has the highest profitability and lowest valuation of any small-cap ETF I track. Along with a solid long-term track record, a 21% estimated earnings growth rate, and high free cash flow margins, it’s worth speculating. The fundamental improvements recently made without sacrificing quality were a pleasant surprise. And since this was the second consecutive positive reconstitution, I’ve decided to upgrade my rating on CALF to a buy.
