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Best And Worst Q4’15: Large Cap Blend ETFs, Mutual Funds And Key Holdings

Summary The Large Cap Blend style ranks second in Q4’15. Based on an aggregation of ratings of 21 ETFs and 841 mutual funds. UDOW is our top-rated Large Cap Blend style ETF and CMIIX is our top-rated Large Cap Blend style mutual fund. The Large Cap Blend style ranks second out of the twelve fund styles as detailed in our Q4’15 Style Ratings for ETFs and Mutual Funds report. Last quarter , the Large Cap Blend style ranked second as well. It gets our Attractive rating, which is based on aggregation of ratings of 21 ETFs and 841 mutual funds in the Large Cap Blend style. See a recap of our Q3’15 Style Ratings here. Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the style. Not all Large Cap Blend style ETFs and mutual funds are created the same. The number of holdings varies widely (from 19 to 1396). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Large Cap Blend style should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 (click to enlarge) * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Arrow QVM Equity Factor (NYSEARCA: QVM ) and the First trust High Income ETF (NASDAQ: FTHI ) are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 (click to enlarge) * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Green Owl Intrinsic Value Fund (MUTF: GOWLX ) is excluded from Figure 2 because its total net assets are below $100 million and do not meet our liquidity minimums. The ProShares UltraPro Dow30 ETF (NYSEARCA: UDOW ) is the top-rated Large Cap Blend ETF and the Calvert Large Cap Core Portfolio (MUTF: CMIIX ) is the top-rated Large Cap Blend mutual fund. Both earn a Very Attractive rating. The Ark Innovation ETF (NYSEARCA: ARKK ) is the worst-rated Large Cap Blend ETF and the Lazard Enhanced Opportunities Portfolio (MUTF: LEOOX ) is the worst-rated Large Cap Blend mutual fund. Both earn a Very Dangerous rating. Wells Fargo & Company (NYSE: WFC ) is one of our favorite stocks held by CMIIX and earns our Attractive rating. Since 2010, Wells Fargo has grown after-tax profits ( NOPAT ) by 14% compounded annually, while simultaneously improving NOPAT margins from 15% to 25%. The company has improved its return on invested capital ( ROIC ) from 8% to 10% over the same timeframe. Despite the business strength, WFC has fallen 4% in the past three months, which has left shares undervalued. At its current price of $55/share, Wells Fargo has a price to economic book value ratio ( PEBV ) of 1.1. This ratio implies that the market expects Wells Fargo’s NOPAT to increase by no more than 10% over its corporate life. If Wells Fargo can grow NOPAT by just 5% compounded annually for the next decade , the stock is worth $68/share today – a 24% upside. Stratasys (NASDAQ: SSYS ) is one of our least favorite stocks held by ARKK and earns our Dangerous rating. Since Stratasys went public in 2012, its NOPAT has fallen from $19 million to -$33 million. In addition to falling profits, Stratasys currently earns a bottom quintile -9% ROIC, which is down from 1% in 2012. Despite the stock being down over 80% from its record high, Stratasys shares could fall even further as the expectations baked into the stock price remain unrealistic. To justify the current price of $23/share, Stratasys must immediately achieve 1% pre-tax margins (-40% in 2014) and grow revenues by 27% compounded annually for the next 16 years. Investors would be wise to steer clear of SSYS. Figures 3 and 4 show the rating landscape of all Large Cap Blend ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs (click to enlarge) Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Funds (click to enlarge) Sources: New Constructs, LLC and company filings D isclosure: David Trainer and Thaxston McKee receive no compensation to write about any specific stock, style, or theme.

Dividend Aristocrats Part 24 Of 52: Consolidated Edison

Summary See why Consolidated Edison is the ultimate ‘tortoise stock’. The company has paid increasing dividends for 41 consecutive years. Are you the type of investor that will benefit from Consolidated Edison stock? Aesop was born into slavery in Greece around 620 BC . His tremendous intelligence did more than earn him his freedom. He rose to become a respected advisor to kings and city-states. One of Aesop’s most famous fables is the tortoise and the hare. An arrogant, speedy hare brags to a plodding turtle about how fast he is. The plodding turtle challenges Aesop to a race. The hare took a commanding lead and looks back, feeling confident that he will win the race. The hare decides to take a ‘power nap’. The slow and steady turtle passes the hare and wins the race. The moral of Aesop’s fable: slow and steady wins the race . Aesop’s story of the tortoise and the hare reminds me of Consolidated Edison (NYSE: ED ). (click to enlarge) Consolidated Edison’s History Consolidated Edison can trace its history back to 1823 – nearly 200 years ago. Back then, the company was known as New York Gas Light Company. In 1884, representatives of several gas light utilities throughout New York came together and consolidated their respective companies into a new business – the Consolidated Gas Company of New York. The company continued to grow and acquire gas, electric, and steam companies serving New York City and Westchester County. In 1936, the company changed its name to Consolidated Edison. Consolidated Edison has paid increasing dividends for 41 consecutive years . The company is the only utility in the S&P 500 with 30+ years of increasing dividends. Consolidated Edison’s dividend growth over the last 41 years is shown below: (click to enlarge) Source: Data from Yahoo! Finance Consolidated Edison Business Overview Consolidated Edison is primarily a regulated utilities business. The company has generated 89% of its revenue from its regulated utilities business segments through the first 9 months of fiscal 2015 . (click to enlarge) Source: 2015 EEI Conference Presentation , slide 25 The company operates in 3 segments: CECONY O&R Competitive Energy Business CECONY stands for C onsolidated E dison C ompany O f N ew Y ork. O&R stands for O range & R ockland. Together, these two segments make up Consolidated Edison’s regulated utilities business. The company’s Competitive Energy Business segment which participates in infrastructure projects, provides energy related products to wholesale and retail customers, and sells electricity purchased on wholesale markets to retail customers. Low Stock Price Standard Deviation & High Yield Investing in ‘turtles’ is not right for everyone. If you are looking for a high dividend yield, safety, and inflation matching (or beating) growth, then Consolidated Edison is a suitable investment. The company’s stock is currently offering investors a high dividend yield of 4.2%. For comparison, the 20 year U.S. Treasury Bond ETF (NYSEARCA: TLT ) is offering investors a yield of just 2.6%. Unlike a bond, Consolidated Edison’s dividend payments are growing (albeit slowly). The company has managed dividend growth of 1.4% a year over the last decade. This is about in line with inflation over the same period. The company should grow its dividend payments faster over the next decade (more on that in the future growth section of this article). Consolidated Edison has a 10 year stock price standard deviation of just 16.7%; the second lowest of any large cap dividend stock with 25+ years of dividend payments [for reference, Johnson & Johnson (NYSE: JNJ ) has the lowest]. You may be wondering… Why does stock price standard deviation matter? There are two answers. First, lower stock price standard deviation means a less ‘bouncy’ ride on your way to total returns. Lower dips make Consolidated Edison stock easier to hold as compared to more volatile stocks. Second, stocks with low stock price standard deviations have historically outperformed the market . That’s why low stock price standard deviation is one of the ranking metrics used in The 8 Rules of Dividend Investing . The image below shows the relative outperformance of the S&P Low Volatility Index over the last decade. The S&P 500 Low Volatility Index is comprised of the 100 lowest volatility stocks in the S&P 500 index. (click to enlarge) Source: S&P 500 Low Volatility Index Factsheet Consolidated Edison’s Future Growth Potential & Total Returns Consolidated Edison grew its earnings-per-share at 3.4% a year over the last decade. Earnings grew around 5%, but the company partially financed itself through share issuances, which dilutes earnings-per-share. In total, the company’s share count has grown at around 1.4% a year over the last decade. Going forward, I Consolidated Edison is expected to grow its earnings-per-share at around 3.5% a year. This number is very close to its 3.4% 10 year historical compound earnings-per-share growth rate. Consolidated Edison’s management is targeting a 60% to 70% dividend payout ratio. The company currently has a 68.8% dividend payout ratio; on the high end of management’s range. As a result, I believe that the company’s dividend payments will increase at either the same rate as earnings-per-share growth for the company, or slightly slower. Investors in Consolidated Edison should expect total returns of around 7.5% a year from the company’s stock. Returns will come from earnings-per-share growth of around 3.5% a year and dividends of ~4% a year. Consolidated Edison stock has a payback period of 16 years using an assumed growth rate of 3.5% and the company’s current share price and dividend. More Safety: Invest In What You Understand Consolidated Edison is an easy to understand stock . The company makes the vast majority of its profits selling electric and gas utility services to both business and residential customers on the East Coast. Other investors have taken notice of Consolidated Edison’s durable geography based competitive advantage. Here’s what Lanny at Dividend Diplomats had to say about the Consolidated Edison : “I understand utilities, I know how they physically work and I know what benefit and value it provides: Providing energy to fuel the day-to-day of operations. Let’s think big businesses, industries, etc., all the way to our entertainment platforms and this stems into our very own households. The need is and for now – will always be there, therefore, this is a very used product that will always be used.” It is very, very likely that Consolidated Edison will be around for a long time in the future. The company operates in a highly regulated industry that creates natural local monopolies. Moreover, the company operates a business that we all use every day (though not necessarily from Consolidated Edison, depending on where you live) – electricity and gas utility services. Peter Lynch is one of the most successful institutional investors of all time. Here’s what he has to say about investing in what you know: (click to enlarge) Final Thoughts: Who Should Buy Consolidated Edison Consolidated Edison stock is not for everyone . The company has a passable-but-not-great expected total return of 7.5%. As a utility, Consolidated Edison does not have rapid, or even average, growth potential. The company’s high dividend yield and high levels of safety (both qualitatively and quantitatively) make it an ideal choice for risk-averse investors looking for high yielding investments that will pay inflation adjusted (or better) dividend payments. Consolidated Edison is the prototypical tortoise investment . Slow and steady dividend growth wins the race.

Targeting 35% Upside For The AES Corporation

Summary We are adding the AES Corporation to our “buy” list. Both the fundamental and technical analyses indicate a potential for a 35% gain over the next few years. The key risk is our assumption that cash flows do not materially deviate from their long-term uptrend. Introduction The AES Corporation (NYSE: AES ) has been exposed to a number of headwinds recently, most notably falling energy prices across the globe, rapidly appreciating U.S. Dollar and weak demand coming from the emerging markets, particularly Brazil, Argentina and Colombia. The most recent negative surprise was the Q3 revenue miss of as much as $1.5bn, which prompted the management to revise down their 2016 earnings guidance below analyst estimates. Cost cutting measures have been put forward to offset the macroeconomic headwinds by 2018 and we see them as a necessary adjustment. It is difficult to judge whether they work out as planned, but it is encouraging to see that the leadership is taking the appropriate steps to keep the business viable. Furthermore, Andres Gluski (the CEO) emphasized their focus on free cash flow as a source of shareholder value, and we believe that this is an appropriate measure for estimation of AES Corporation’s long-term investment value. Valuation Our valuation model for AES is based on the company’s ability to generate cash. The key measure of cash flows that we use is free cash flow, which is the total cash inflow from operations minus the dividends and capital expenditure outlays. This is effectively the amount of “excess” cash that the company is making and therefore accruing to its lenders and shareholders. While we do look at historic cash flows, cash flows projections are of crucial importance because markets are forward looking. Our estimated cash flows for the next 10 years are simply based on the previous trend, as we do not have access to analyst estimates for AES. After 10 years, we assume that the growth rate of cash flows falls back to its previous trend and remains on it for the next 10 years, after which it normalizes towards the sustainable rate of 3.9% per annum, based on the average real GDP growth over the last 15 years and the average inflation rate of 2%. The chart below shows the historic (blue line) and projected free cash flows (red line). (click to enlarge) To calculate the total value of the firm, we discount the projected cash flows and the company’s terminal value by its weighted average cost of capital ( OTC:WACC ). Our estimate of AES’s cost of debt is 7.28%, based on their interest expense and amount of debt outstanding in the last fiscal year. The cost of equity is calculated using the 10 year treasury yield as the “risk-free” proxy plus the implied equity risk premium of 9.13% times the historic beta of 1.1675 for the stock. Some of the other key metrics summarized below: •Beta = 1.17 •ERP = 5.98% •Cost of Debt = 7.28% •Cost of equity = 9.13% •Debt to Assets = 54.45% •WACC = 7.73% •Current Price = $9.9 •Fair Price = $26.52 (167.9% return) After discounting the projected free cash flows and the company’s terminal value in 10 years’ time, we subtract the current value of debt and arrive at the total equity value of 17,887,985, which equates to $26.52 per share. With today’s share price at $9.9, re-pricing towards the estimated fair value would require a return of 167.9%. The green line in the below chart represents the estimated “fair value” per share, with the dashed lines showing the upper and lower bounds of the confidence interval based on stock’s volatility. (click to enlarge) Relative Valuation American Electric Power Company (NYSE: AEP ), Pinnacle West Cap. (NYSE: PNW ), Firstenergy (NYSE: FE ), Nrg Energy (NYSE: NRG ), Consolidated Edison (NYSE: ED ), Cms Energy (NYSE: CMS ), Dte Energy (NYSE: DTE ), Entergy (NYSE: ETR ), Nextera Energy (NYSE: NEE ), Dominion Resources (NYSE: D ), Xcel Energy (NYSE: XEL ), Exelon (NYSE: EXC ), Ppl (PP and), Pg&E (NYSE: PCG ), Pub.ser.enter.gp. (NYSE: PEG ), Edison Intl. (NYSE: EIX ), Southern (NYSE: SO ), Teco Energy (NYSE: TE ), Pepco Holdings (NYSE: POM ), Eversource Energy (NU) are AES’s closest peers within the S&P 500. The table below can help us understand AES’s valuation in relative terms. Table 1: Relative Valuation Table, S&P 500 peers AES AEP PNW … Median Lower Quartile Upper Quartile PE 11.60 15.10 17.20 … 16.90 13.23 20.50 PC 2.48 6.31 6.33 … 6.31 4.81 6.83 PB 1.63 1.58 1.57 … 1.61 1.56 1.75 ROE 17.02 10.13 9.46 … 10.13 9.08 11.51 EPS Growth (5 year) -1.03 2.39 39.79 … 1.03 -1.73 6.80 Beta 1.17 0.58 0.72 … 0.59 0.55 0.69 AES Corporation benefits from very low price multiples, which indicates that the bad news are already in the price. price to earnings ratio of 11.6x is below the lower quartile for the group (13.2x). The same is the case for the price to cash flow and price to book multiples, currently standing at 2.5x and 1.6x, respectively. (click to enlarge) Even more importantly, the price to book ratio of 1.6x looks very attractive in the context of the return on equity of 17.0%. The chart above shows that this makes the company look significantly undervalued relative to peers, given the current industry relationship between this price multiple and underlying profitability. The stock looks attractive from the technical perspective as well. While in the short term the price could fall to as low as 8.6%, a failure to break below this level would confirm the wedge-like formation in play, targeting roughly 35% upside, depending on the timeframe. While a potential break below the support would imply further short term weakness, we see current price as an opportunity to buy due to the 2.5 times greater upside. Of course, if rate hikes in the U.S. push the U.S. dollar higher, investors will need to exercise more patience until the target is reached. (click to enlarge) Conclusion In summary, the company leadership has already taken action to counter the unfavorable impact of macroeconomic developments across the globe. The cost cutting measures that are aiming to support the free cash flow generation through 2018 may or may not work as planned, but investors should focus on risk management and diversification rather than crystal ball gazing. Our discounted cash flow model indicates roughly 35% upside (the lower end of the fair value range, the conservative target), which is also supported by long-term technicals. AES Corporation looks significantly undervalued relative to peers as well, thereby ticking all our boxes. As a result, we are adding this stock to our “buy” list today.