COWZ And DSTL ETFs Set To Outperform

Editor’s note: Seeking Alpha is proud to welcome Rahul Chahal as a new contributor. It’s easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

Investment portfolios are generally built by diversifying across large-cap, mid-cap, small-cap, international, and other niche investment categories. Among the choices for large-cap retirement options are the SPDR S&P 500 Trust ETF (SPY) and the Vanguard S&P 500 ETF (VOO), which are market cap weighted like the S&P 500 index and are extremely low cost. However, there are other choices. The Pacer US Cash Cows 100 ETF (BATS:COWZ) and the Distillate Fundamental Stability & Value ETF (NYSEARCA:DSTL) are constructed using free cash flow, among other criteria. Free cash flow adds an extra layer of protection, a sensible thing given increasing interest rates, and a prudent way to select an investment. COWZ is an ETF by Pacer Financial, while DSTL is an ETF by Distillate Capital.

Background

The S&P 500 has returned an average of 7%-11% annual returns, with dividends reinvested over a 20-plus-year investment period during the post-World War period. Higher volatility like we are now experiencing reduces portfolio returns. ETFs like COWZ and DSTL are categorized as factor ETFs. Factor ETFs are created using various methodologies, and employ a different set of screening criteria such as dividends or momentum or lowest volatility.

COWZ selects 100 companies from the Russell 1000 index by screening for free cash flow, quality of earnings, the strength of the balance sheet, long-term growth, and an ability to generate income over time. To calculate free cash flow yield, COWZ uses the ratio of trailing 12 months of free cash flow to enterprise value. Enterprise value incorporates debt and cash into the market capitalization. COWZ rebalances regularly – thus, stocks have to be among the top 100 out of 1,000 stocks screened.

Distillate Capital utilizes a proprietary methodology of value, quality, and risk to select 100 companies from S&P 500. DSTL utilizes free cash flow and fundamental criteria like valuation and debt to income as critical to the success of long-term investing. The criteria are based on specific metrics of free cash flow-based valuation, long-term fundamental stability, and balance sheet quality. Value focuses on through cycle durability of an asset’s cash generation and indebtedness. Quality focuses on long-term fundamental stability and leverage. Risk does not focus on short-term fluctuations in price, but rather operates as a function of quality and value. DSTL rebalances its portfolio of top 100 stocks quarterly from S&P 500.

Performance

The first chart below compares COWZ, DSTL, and SPY from the inception of DSTL. In the past four years, COWZ is up 56%, DSTL is up 53%, and SPY is up 35%.

Since the COVID-19 lows in April 2020, COWZ is up 111%, DSTL is up 66%, and SPY is up 50%.

In 2022, COWZ is down 8%, DSTL is down 18%, and SPY is down 24%. This year has been a test for stocks, bonds, and commodities. Considering the challenging year, COWZ and DSTL have held up better than SPY – which is one of the better performing indices.

Below is a look at the current holdings, annual fees, and dividend yields for the ETFs at the time this article was written.

The top holdings for SPY are:

• Apple (AAPL): 6.93%
• Microsoft (MSFT): 5.77%
• Amazon (AMZN): 3.33%
• Tesla (TSLA): 2.35%
• Google (GOOGL): 1.90%
• Google (GOOG): 1.71%

The top holdings for COWZ are:

• Regeneron Pharmaceuticals (REGN): 2.61%
• Marathon Petroleum (MPC): 2.22%
• ConocoPhillips (COP): 2.20%
• Cheniere Energy (LNG): 2.15%
• Pioneer Natural Resources (PXD): 2.14%

The top holdings for DSTL are:

• Google (GOOGL): 4.02%
• UnitedHealth Group (UNH): 2.49%
• Johnson & Johnson (JNJ): 2.46%
• AbbVie (ABBV): 2.03%
• Home Depot (HD): 1.99%

COWZ charges an annual fee of 0.49% and yields 1.7%, while DSTL charges an annual fee of 0.39% and yields 1.3%.

Ratings

Morningstar has given a five-star rating to both COWZ and DSTL based on its risk-adjusted performance compared to over 1,200 funds in the Morningstar Large Blend category. Lipper rates DSTL a 5 for total returns, a 5 for consistent return, a 5 for capital preservation, a 5 for tax efficiency, and a 4 for expense. Lipper rates COWZ a 5 for total returns, a 5 for consistent returns, a 4 for capital preservation, a 5 for tax efficiency, 4 for expense.

Risks

COWZ and DSTL have not gone through a long bear market, so it’s hard to judge how well they will hold up in a severe and prolonged downtrend. However, so far in this current bear market COWZ and DSTL are handily outperforming SPY. Higher interest rates could lead to an economic slowdown, and companies within COWZ and DSTL will see revenue and profit growth challenged – thus impacting the performance of both funds.

Conclusion

COWZ and DSTL have outperformed SPY in up and down markets. Both funds have outperformed due to their proprietary screening criteria and regular rebalancing, thus selecting the top 100 free cash flow companies from their universe of companies. Due to the superior quality selection, both COWZ and DSTL should continue to outperform.

Buyers of these funds are not going to be those looking for high dividends. However, they are targeted for those seeking long-term growth of their investment. As a core long-term investment holding there are numerous choices out there, but I recommend both COWZ and DSTL. Based on one’s time horizon and risk tolerance, a certain percentage of one’s funds can be allocated to both ETFs.