The Free Cash Flow Yield ETF Portfolio

While market cap weighting is still the go-to for many investors due to its low cost and low turnover, it's becoming increasingly fragile these days thanks to the concentration risk among a handful of tech sector mega caps.

There are plenty of ways to diversify away from this concentration risk. For example, WisdomTree's ETFs use a strategy that weights by dividend payments and often screens for consistent earnings-per-share (EPS) growth, return on equity (ROE), and return on assets (ROA). I’m a big fan of WisdomTree, especially since their approach is grounded in Jeremy Siegel's research.

But another contender gaining popularity with advisors is Pacer ETFs, particularly their "Cash Cow" ETF lineup. These ETFs take a different approach by screening for free cash flow yield.

At the end of the day, when you buy stocks, you're buying a business—and just like if you were opening a convenience store or a restaurant, all you should care about is, "How much cash can I get out of this business?"

Here's a look at my three favorite Pacer "Cash Cow" ETFs and how to combine them into a robust core U.S. equity portfolio.

Why screen for free cash flow yield?

Free cash flow (FCF) is one of the most reliable metrics for evaluating a company's financial health. It essentially shows how much cash a business generates after covering its expenses, taxes, interest payments, and long-term investments.

What makes free cash flow a better metric than earnings per share (EPS) is its resistance to manipulation. EPS can be easily adjusted through accounting tactics like altering depreciation schedules or using share buybacks to reduce the share count.

In contrast, free cash flow reflects the actual cash a company has on hand, making it a more accurate gauge of business efficiency.

But to truly measure the value of free cash flow, we look at free cash flow yield, which is calculated by dividing free cash flow by enterprise value (EV).

Enterprise value is the market capitalization of a company, adjusted by adding its debt and subtracting its cash. These adjustments are important because they provide a more complete picture of a company's total valuation.

Adding debt accounts for the fact that acquiring a business means taking on its liabilities, while subtracting cash acknowledges that available cash can offset acquisition costs, improve liquidity, or pay down debt.

A high free cash flow yield often signals a business that generates substantial cash relative to its valuation. These businesses often have good cost control and disciplined capital spending, allowing them to produce cash consistently.

One of the main advantages of high free cash flow is the flexibility it provides. Companies with ample cash flow can increase dividends, providing shareholders with a more substantial and reliable income stream. They can also buy back shares, which reduces the share count and can boost the stock price.

Paying down debt is another option, improving the balance sheet and reducing financial risk. Finally, these companies can reinvest in growth, funding new projects, acquisitions, or research and development without needing external financing.

Putting free cash flow yield in play

Our core U.S. equity portfolio with a free cash flow yield tilt will begin with 60% allocated to the Pacer US Cash Cows 100 ETF (COWZ).

This is Pacer’s flagship fund, boasting a five-star Morningstar rating and outperforming the majority of mid-cap value ETFs on a risk-adjusted basis. With $25 billion in assets under management and a 0.49% expense ratio, COWZ is well-capitalized and reasonably priced for its strategy.

The approach here is straightforward. COWZ takes the Russell 1000 Index, narrows it down to the top 100 companies based on free cash flow yield, and weights them by their trailing 12-month free cash flow yield, with a 2% cap to prevent over-concentration.

Source: Pacer ETFs

To add a size tilt, we'll complement this with a 20% allocation to the Pacer US Small Cap Cash Cows 100 ETF (CALF). I like CALF because it draws from the S&P SmallCap 600 Index instead of the Russell 2000, which has a built-in profitability screen to weed out junk—something the small-cap space sorely needs.

The screening process is virtually identical to COWZ, again focusing on high free cash flow yield with the same ranking methodology and 2% cap.

Source: Pacer ETFs

Finally, we want to barbell the small-cap value allocation in CALF with a large-cap growth tilt. Small-cap value and large-cap growth often pop in and out of favor, so balancing these exposures can capture a rebalancing premium. The ETF for this purpose is the Pacer US Cash Cows Growth ETF (BUL).

BUL uses the same strategy as COWZ and CALF but starts with the S&P 900 Pure Growth Index, which combines the S&P 500 for large caps and the S&P MidCap 400.

The initial screening process for the S&P 900 Pure Growth Index evaluates three-year sales per share growth, the three-year ratio of earnings per share change to price per share, and momentum based on the 12-month percentage change in price. Then, it applies the same free cash flow yield filters as the other Cash Cows ETFs.

Source: Pacer ETFs

The results speak for themselves. A portfolio with 60% allocated to COWZ, 20% to CALF, and 20% to BUL, rebalanced quarterly from May 3, 2019, to February 28, 2025, delivered an impressive 13.04% CAGR.

Source: Testfolio.io