Making money usually requires a lot of effort. You have to actively work at a job. Even passive income sources often require hands-on activity, like managing a rental property or a portfolio of dividend stocks.
However, some income options are effortless. Investing in dividend ETFs is one of the easiest ways to generate passive income. These managed funds typically hold a diverse pool of income-generating assets, making them a simple way to collect passive income.
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One ideal dividend ETF for passive income is the Pacer Global Cash Cows Dividend ETF (NYSEMKT: GCOW). It can turn a $10,000 investment into more than $400 of annual dividend income at its recent dividend rate of more than 4%. You don’t need that much to get started. Every $100 invested in the fund would produce over $4 of dividend income each year.
Here’s a closer look at this income-focused fund.
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Focused on free cash flow machines
The Pacer Global Cash Cows Dividend ETF is a strategy-driven fund. It aims to unearth companies that can pay consistent dividends because they generate lots of free cash flow. It screens companies by their free cash flow yield and dividend yield.
The fund hunts for dividend stocks among the world’s 1,000 largest companies. It screens these companies and pulls out the top 300 based on their free cash flow yields. It then screens those stocks by their dividend yields.
The ETF takes the top 100 companies by dividend yield, weighting them in the fund by their yield, capped at 2%. It rebalances and reconstitutes its holdings twice each year.
At its last refresh in December, the fund’s holdings had an average free cash flow yield of 6.3% and a dividend yield of 5%. The dividend yield was closer to 4% based on the fund’s last annualized payment and recent share price.
Cash cows pay dividends
Many dividend ETFs focus on companies based on their dividend yields or histories. The Pacer Global Cash Cows Dividend ETF focuses on the fuel that funds dividends: free cash flow. Free cash flow, which is the cash a company produces after expenses, interest, taxes, and long-term investments, is the source of dividend payments (and share repurchases).
It screens companies based on their free cash flow yield, which is their free cash flow per share divided by the share price. Having a high free cash flow yield indicates two things.
First, it means that the company produces a lot of cash, giving it a high capacity to pay dividends. It also implies that the company has a lower valuation. While a company with a high dividend yield can imply a high dividend payout ratio, having a high free cash flow yield and a high dividend yield indicates that the stock trades at a lower valuation and should be able to sustain its dividend.
Investing in companies that produce a lot of cash, also known as cash cows, has other benefits. They tend to deliver long-term capital appreciation because they trade at a lower valuation, giving them more potential for valuation expansion. These stocks also tend to be less volatile, which can help cushion the blow during market downturns. Meanwhile, the higher dividend yields provide investors with more dividend income, which is a tangible return.
Since its formation in 2016, the fund has produced an 8.8% annualized total return. At that rate, the fund would have grown a $10,000 investment made at its inception into nearly $23,000 (assuming reinvested dividends). While other investments have produced higher returns, this fund has produced a solid return (which includes meaningful dividend income) with less volatility than other investments. That makes it ideal for those seeking a lower-risk, income-focused investment.
An easy way to collect dividend income
The Pacer Global Cash Cows Dividend ETF focuses on companies that produce a lot of cash because that enables them to pay attractive dividends. It zeros in on companies with higher free cash flow yields and high dividend yields. Because the fund managers do all the work, it’s an effortless way to collect passive income.
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Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
