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SCHD: A Natural Core Holding For Dividend Growth Investors

Summary SCHD offers a great portfolio for dividend investors to build around. During previous recessions (and corrections) the dividend paying companies of the S&P 500 held up better than those without dividends. With the high P/E ratios climbing over the last few years we have seen the market become more dangerous. Dividend stocks underperformed the last few years as the market became more bullish (expensive). A more bullish market makes me prefer SCHD over SPY. The holdings offer some great stocks and exposures that create natural hedges to the macroeconomic challenges. Dividend growth stocks offer investors a solid combination of current income and growth, but some investors still don’t understand their power. One of my favorite ETFs for this sector is the Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ). Some investors will point out that they can pick and choose which individual dividend stocks offer the most compelling investments and there is nothing wrong with that plan. If an investor feels comfortable picking out individual stocks, they are welcome to do so. However, every investor needs to remember to stay diversified and that is where a low fee dividend ETF comes in. The Schwab U.S. Dividend Equity ETF has an expense ratio of only .07, is free for trading in Schwab accounts, and offers investors a yield of 2.88%. That isn’t a great yield, but it isn’t bad when considering how many companies the ETF needs to provide solid diversification. In this area I favor enhanced indexing. SCHD doesn’t need to be the only dividend investment in the portfolio, but it provides a solid piece to build around. Dividend Growth Performance Investors looking at returns over the last few years may feel like SCHD is failing to keep up with the market, but that is a natural consequence of the market getting bullish on stocks that don’t pay dividends. I prefer stocks with solid dividends. While investors should consider total return, I see no reason to move away from dividend stocks. Instead, I see the recent underperformance as making them more attractive. Since early November 2011, right after SCHD was formed, it has delivered returns of 64.6% compared to the SPDR S&P 500 Trust ETF ( SPY) delivering 79.13%. That weakness for SCHD has been a reflection of the large dividend stocks underperforming the index as shown in the chart below. (click to enlarge) Dividend stocks are out of favor and appeared to be going out of favor since 2012. As the P/E ratios climb to dangerously high levels, I would rather invest in the companies that are paying out dividends and delivering a meaningful portion of their earnings. I would rather invest in industries with strong dividend payouts. During the weakest markets, these stocks have held up better. If this market overheats, then SCHD looks like a great option to survive the weakness. If investors want to avoid losing by selling out at the bottom of a market, they would be wise to hold an investment where they can focus on the dividends rather than the panic. Holdings The following chart shows the top holdings of the Schwab U.S. Dividend Equity ETF ranked by their values. (click to enlarge) What dividend growth investor doesn’t like these companies? In my opinion, this is precisely the kind of diversification a dividend investor should be seeking. Who doesn’t like Procter and Gamble (NYSE: PG )? Some analysts can get bearish on it or argue that it is over-valued, but the point of the diversification is to protect investors from overpaying for a few companies. Verizon Communications Inc. (NYSE: VZ ) is one of the high yielding stocks (4.66%) that concern me because the telecommunications industry looks far less attractive when Sprint (NYSE: S ) is waging a price war that could severely damage earnings throughout the industry. I love the yield, but I have tried holding companies that in highly competitive industries marked by excessive growth of capacity and battles to deliver the lowest price. That was the investment where I had my worst losses and it taught me to be very wary of price based competition with excessive building of capacity. Exxon Mobile Corp. (NYSE: XOM ) is a great play on the oil industry and either it or another major oil company belongs in every dividend growth investor’s portfolio. The beauty of oil is that crashing prices on oil mean more income for middle class and lower class consumers. Cheap oil means lower costs for transporting materials. Cheap oil is good for most of the portfolio. On the other hand, expensive oil is a headwind for many major companies and a tailwind for the big oil players like XOM. This should be a natural holding for dividend growth investors. Conclusion SCHD is a solid way for investors to get a core holding for their dividend growth portfolio. It offers an excellent selection of major dividend growth champions which allows investors to build their portfolio around those champions by overweighting the companies that best align with their risk tolerance and goals. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Hedging A PayPal Spin-Off Arbitrage Investment Strategy

PYPL and EBAY stocks are expected to start trading in the “when-issued” market this week. Introducing four investment strategies for different levels of risk tolerance. The PayPal spin-off investment scenario reflects an expected return of 2% to 11%. The long waiting period is finally coming to an end as PayPal (Pending: PYPL ) and eBay (NASDAQ: EBAY ) are getting closer to the first spin-off milestone – July 8th, the spin-off record date. The record date has some significant meanings in this context: Holders of EBAY shares will be entitled to receive PYPL at the distribution. The first batch of (largest) shareholders will receive their distributed shares. Trading at the “when-issued” market begins based on shares distributed in the first batch. After the previous article published about the PayPal spin-off arb strategy, I received many questions about how to create an optimized position that would benefit from this spin-off arb opportunity in a hedged environment. I answered some of this questions, and I want to present some scenarios that will assist readers and potential investors to tailor the best position to meet their unique characteristics. At the beginning, I wish to address two primary issues that are fundamental to this investment strategy: risk aversion and outflow theory. Before investing in the PayPal spin-off (if investing at all), investors should know exactly what their risk appetite is. Some investors take high risks in anticipation of higher returns than usual, and other investors take small risks and expect moderate gains. Both approaches are perfectly fine, but an individual investor should think of that before engaging with a spin-off arbitrage strategy and create an investment strategy that fits his or her risk aversion preferences (institutional investors assess their risk appetite regularly). Investors looking to gain from a short-long position should accept the outflow theory that I presented in a May article . An investor who believes that both eBay and PayPal will soar after the split should engage in a different strategy, which I will not cover here, and hold both equities long. To create a trading scenario for the spin-off, I will assume that most readers will receive the distributed shares between a week after the record date and the distribution date. At this point, EBAY.wi and PYPL.wi shares already reflect a 10% price fluctuation. Let’s discuss the four possible scenarios: Scenario A: take no action during the spin-off; Scenario B: hold only long position (sell 100% EBAY); Scenario C: hold long and short positions at a 2:1 ratio (sell 50% EBAY); Scenario D: hold long and short position of the same size. I also assume that the PYPL.wi price will increase by 5% during the period I described above, 3% during the weekend between the distribution date and PYPL’s first trading day, and an additional 10% on the first trading day. All figures are within the reasonable spin-off fluctuations that were presented in the previous article. I also assume that the positive changes in PayPal’s stock price equal the adverse changes in eBay’s stock price. I calculated the return and volatility based on a distributed share price of $32 for a PayPal share and $28 for an eBay share, assuming cash from selling the EBAY stock was not reinvested. The four scenarios presented above yielded the following return and volatility figures: Scenario A B C D Return 2.1% 7.1% 9.0% 10.9% Volatility 1.05% 2.80% 3.39% 4.01% Investors highly averse to risk can choose to take action and get an estimated return of 2% of scenario A or just sell all units of the EBAY stock once received and gain 7% from a PYPL long-only position as presented in scenario B in the period between the moment the distributed shares are received until the end of the first day of trading in PYPL shares. Investors who have some tolerance for risk can choose a long-short strategy that maximizes return from the spin-off but is accompanied with a slightly higher risk. Scenario C, which suggests to sell 50% of eBay’s distributed shares and short the other 50%, offers a lower risk for investors than scenario D. Investors who are somewhere in the middle between complete risk aversion and total risk taking could choose a larger/smaller quantity of EBAY shares to sell in order to hedge PYPL fluctuations. Investors who hold options of eBay pre-distribution can add an additional hedging layer with post-distribution options and protect their positions better from any downside. However, since the outflow of cash that is expected from PYPL and EBAY will trigger a possible movement in prices, it might be easier to hedge the position by playing with the ratio between the long and short positions. Disclosure: I am/we are long EBAY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer’s opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.

Aetna Finally Agrees To Buy Humana: ETFs In Focus

The insurance corner of the health care sector has been the hottest lately as the five big managed health care insurers are in talks of consolidation. In the latest match-up merger game between Aetna (NYSE: AET )-Humana (NYSE: HUM ) and Aetna-UnitedHealth (NYSE: UNH ), it seems that Humana has finally won following weeks of speculation. Aetna-Humana Deal in Focus In the deal announced on the eve of the July Fourth weekend, Aetna will buy Humana for about $37 billion, or about $230 per share in a cash-and-stock deal. Per the terms, Aetna will pay $125 in cash to Humana shareholders, a 23% premium to its closing price as of June 2, and 0.8375 share for each Humana share. Aetna’s shareholders will own about 74% in the combined company, while Humana’s shareholders will own the rest. The combination, if successful, would be the largest ever in the managed health care insurance space, dwarfing the recently announced $28 billion takeover offer of Chubb Corp. (NYSE: CB ) by ACE (NYSE: ACE ) and Anthem’s (NYSE: ANTM ) $16.6 billion purchase of WellPoint in 2004. The deal would push Aetna close to the second-largest insurer – Anthem – in terms of membership and would nearly triple its market share in the rapidly growing Medicare Advantage business. It will also bolster Aetna’s presence in the state and federally funded Medicaid program and Tricare coverage for military personnel and their families. With this, the combined company is expected to generate revenues of $115 billion in 2015, with 56% coming from government-sponsored programs such as Medicare and Medicaid. The acquisition, expected to be completed in the second half of next year, has already been approved by the board of directors of both companies and is seeking approvals from the shareholders and regulators. The transaction will be neutral to earnings in 2016 but accretive to earnings in mid single digits in 2017 and low double digits in 2018. The proposed merger has put the spotlight on the iShares U.S. Healthcare Providers ETF (NYSEARCA: IHF ), which could be the best way for investors to tap the opportunity arising from the AET-HUM deal. The shares of HUM are up 3.4% in the pre-market trading today while Aetna dropped over 6%. IHF in Focus This ETF follows the Dow Jones U.S. Select Healthcare Providers Index with exposure to companies that provide health insurance, diagnostics and specialized treatment. In total, the fund holds 51 securities in its basket with Aetna occupying the third position accounting for 6.6% share and Humana taking up the seventh spot at 4.6%. The fund has amassed over $1 billion in its asset base while volume is moderate at about 87,000 shares per day on average. It charges 43 bps in annual fees and expenses and has gained 20.4% so far this year. The product has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a Medium risk outlook. Other ETF Options While IHF is undoubtedly the solid pick in the health care space to take advantage of the planned merger, other choices are also available from the large-cap space. Among them, the ValueShares U.S. Quantitative Value ETF (BATS: QVAL ) provides a decent exposure to both Aetna and Humana with a combined share of 5.8%. The ETF invests in the cheapest highest quality value stocks, holding 41 stocks in its basket. It has amassed $55.5 million in its asset base while volume is paltry at around 16,000 shares. It charges 79 bps in annual fees. The Direxion iBillionaire Index ETF (NYSEARCA: IBLN ) could also be the way to capitalize gains resulting from the Aetna-Humana deal. The fund provides an opportunity to invest like billionaires by tracking the iBillionaire Index. It has an equal-weighted portfolio of 31 large-cap stocks with Humana as one of its holdings. The product has AUM of $31.7 million and charges 65 bps in fees from investors. Volume is low, exchanging 12,000 shares in hand per day. Original Post