Tag Archives: seeking-alpha

3 Dividend ETFs With Yields Over 3% And 1 Coming Respectably Close

Summary These four dividend ETFs have similar expense ratios but substantially different holdings. DVY looks like the ETF with the highest chance to go on sale in December if the Fed Funds rate is increased. DVY and DTN have zero exposure to real estate which may be favorable for investors concerned about income taxes on REITs. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered and explaining what I like and don’t like about each in the current environment. The Four ETFs Ticker Name Index QDF FlexShares Quality Dividend Index ETF Northern Trust Quality Dividend Index DHS WisdomTree Equity Income ETF WisdomTree High Dividend Index DTN WisdomTree Dividend ex-Financials ETF WisdomTree Dividend ex-Financials Index DVY iShares Select Dividend ETF Dow Jones U.S. Select Dividend Index By covering several of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. For investors that want to see precisely which assets I’m holding, I opened my portfolio near the end of November. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. The FlexShares Quality Dividend Index ETF is the weakest of the batch on dividend yields, but I wouldn’t consider 2.78% even remotely bad. That is a very respectable dividend yield for an equity portfolio that is not focused on carrying REITs, BDCs, or other very high yield investments. The two WisdomTree funds both come in with very high dividend yields. (click to enlarge) Expense Ratios These funds are all extremely similar on expense ratios. (click to enlarge) Sector Even if an investor was going to focus on dividend yields, there are three funds with yields that are materially above 3%. The expense ratios are also very similar which reinforces that investors need to be looking at the sector allocations to make the determination of which ETF makes the most sense for them. I built a fairly nice table for comparing the sector allocations across dividend ETFs to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) First Glance I imagine most readers looking at that glance first noticed the exceptionally tall purple bar representing the utility allocation for DVY. This is a dividend growth fund that has a fairly huge allocation to the utility sector. DVY DVY uses a very heavy allocation to utilities. For investors that already build their own utility positions in their portfolio, this wouldn’t be a great fit since it would double up on the exposure. On the other hand, for the investor that does not have utility exposure in their portfolio, the ETF could be a great fit. The utility sector often demonstrates some correlation with bonds because investors treat it as an alternative source of income. This may be a fairly volatile sector going into December because investors are expecting the Federal Reserve to raise rates and if a rate increase is confirmed it could send bond yields higher and utility stocks would be expected to fall at the same time so that the dividend yields would increase. I won’t be surprised if the Federal Reserve raises rates in December, but if they manage to raise rates 5 more times within the next year and a half I would be quite surprised. I don’t expect great results on the increase in rates, so I don’t think the following years will see further increases. I wouldn’t be surprised if see the Federal Reserve’s short term rate fall back to 0% before it makes it up to 1%. DTN and DVY In addition to being heavy on utilities, DVY joins DTN in having no allocation to real estate. I don’t mind the exclusion of real estate since I expect many investors may want to use this kind of dividend growth ETF in a taxable account while pushing their REIT exposure into a tax exempt account. For an investor putting a large part of their portfolio in either of these ETFs, it would be reasonable to look for some exposure to REITs somewhere else in the portfolio. I’m using equity ETFs for around 20% to 25% of my portfolio and I may look to increase that in December and going into next year if the REITs are on sale following an increase in the Fed Funds rate. DTN also has virtually no exposure to the financial services sector. Since their name includes “ex-Financials”, I think that makes a great deal of sense. DTN would fit best in a portfolio where the investor was manually choosing their own bank stocks and REITs for the portfolio. QDF QDF offers the lowest dividend yield and when I look at the sector allocations it appears fairly aggressive for a dividend portfolio. The allocation to utilities and consumer defensive are both fairly low and in both cases QDF has the lowest allocation in the portfolio. In my opinion, the best scenario for QDF relative to the other ETFs would be a longer bull market where more aggressive allocations would be rewarded. Compared to an actual aggressive allocation, this would be fairly tame but when compared to other high yield portfolios it is less defensive. What do You Think? Which dividend ETF makes the most sense for you? Do you use DVY to get your utility allocation, or do you pick your own utilities (or use a different ETF)? Is the dividend yield on DVY or DTN enough to bring you into the ETF? The only major weakness I see for this batch of ETFs is that the expense ratios are higher than I would like to see. However, when choosing between these four ETFs the ratios are very comparable.

HACK: Too Much Industry Hype, Too Little Fundamental Support

Summary Cyber-security market top line growth doesn’t necessarily translate to profit growth for companies. Most companies are still spending a large portion of gross profit on R&D for new software/hardware solutions and marketing & selling to boost brand recognition and gain market shares. Until the industry consolidates and SG&A costs stabilize, it’s hard for these companies to retain profits. Recommendation: Sell Although the cybersecurity market is expected to grow at a phenomenal rate, in my opinion it doesn’t necessarily translate to profit growth for companies. Since cybersecurity is a relatively new industry, most companies are still spending a large portion of gross profit on R&D for new software/hardware solutions and marketing & selling to boost brand recognition and gain market shares, resulting in negative bottom line for most companies. Choppy as the cash flow from operation (CFO) growth is, most cybersecurity companies have positive operating cash flow and incur little CapEx. Going forward, keeping up with hacker’s technology requires constant R&D spending on upgrading and updating technology, and large marketing & selling expense to compete for market shares remains a headwind for these companies in this highly fragmented market. Until the industry consolidates and SG&A costs stabilize, it’s hard for these companies to retain profits. ETF Info Price 27.16 52 Wk H 33.91 52 Wk L 18.29 30D Avg Volume 396,270 Market Cap 1,114,917,969 Shares Out 41.05 Return YTD 3.66% Excess Return YTD -1.97% Tracking Error 1.70 Inception Date 11/12/2014 Expense Ratio 0.75% ETF Summary The PureFunds ISE Cyber Security™ ETF (NYSEARCA: HACK ) tracks the price and yield performance of the ISE Cyber Security™ Index, which includes companies or ADRs that are hardware/software developers for cyber security (“Infrastructure Providers”) or non-development service providers (“Service Providers”). The ISE Cyber Security index assigns weights to companies according to category (“Infrastructure providers”/”service providers”) and then is adjusted according to liquidity and market cap. For more information, you can refer to the PureFunds website . Companies Updates When looking at financial statements of the holding companies, other than 6 companies that had negative sales growth for the past year (~-5%), 26 companies had 10%+ sales growth with on average 70% gross margin. A large chunk of gross profit goes to R&D and Selling & Marketing expenses, resulting in negative profit margin for some of the companies. The gap between sales growth and net income growth is largely attributable to SG&A spending. Most of these companies don’t incur much CAPEX and have positive free cash flow when adding back non-cash charges (mostly stock-based compensation and debt amortization). However, the stock-based compensation is a meaningful real expense and will likely to continue due to continuous talent acquisitions. Operating cash flow growths are choppy and unpredictable. These companies have a median forward PE of 22.7x and average forward PE of 40x (vs. S&P 500 average 18.7x forward PE). Among the top 10 holdings, 5 are experiencing fast sales growth for the past several years, 4 have stagnant growth, and 1 had negative growth (shown later in this article). MIN MAX MEDIAN AVERAGE S&P 500 Sales growth (%, FY) -23.2 163.5 8.2 16.1 Net Income growth (%, FY) -2620.1 1865.2 -11.4 -70.9 EBITDA growth (%, FY) -230.5 123.6 5.2 -14.5 CFO growth (%, FY) -122.4 302.8 3.7 21.3 FY Gross margin 9% 95% 76% 67% FY EBITDA margin (adj) -89% 62% 11% 8% FY Operating margin -111% 56% 9% 4% FY Net margin -112% 44% 5% -1% FY CFO/sales -31% 59% 19% 18% FY FCF/sales -47% 56% 14% 14% FY capex -3879.7 -1.4 -14.5 -244.8 FY FCF/capex -2.9 60.7 4.4 8.0 PE(forward) 13.7 312.1 22.7 40.4 18.7 PB 0.9 38.8 5.1 7.5 2.8 *data gathered from yahoo finance and Bloomberg, compiled by author Looking at the table above, the median sales growth is 8%, meaning more than 50% of these companies are doing fine on the top-line. However, median net profit growth is negative, meaning profits for more than 50% of the companies are shrinking. Would you buy into an industry where profits for companies are stagnant or shrinking? Probably not. What worsens the situation is the assigned weights. This ETF is almost as if it’s assigning equal weight to all the companies – the largest holding is 4% and the smallest is

Cheap Funds Dupe Investors – Q4 2015

Summary Comparison of AUM in funds with attractive holdings versus attractive costs. Distribution of ETFs and mutual funds by Predictive Rating and our two component ratings. Commentary on the shortcomings of traditional ETF and mutual fund research. Fund holdings affect fund performance more than fees or past performance. A cheap fund is not necessarily a good fund. A fund that has done well in the past is not likely to do well in the future ( e.g. 5-star kiss of death and active management has long history of underperformance ). Yet, traditional fund research focuses only on low fees and past performance. Our research on holdings enables investors to find funds with high quality holdings – AND – low fees. Investors are good at picking cheap funds. We want them to be better at picking funds with good stocks. Both are required to maximize success. We make this easy with our predictive fund ratings. A fund’s predictive rating is based on its holdings, its total costs, and how it ranks when compared to the rest of the 6700+ ETFs and mutual funds we cover. Figure 1 shows that 69% of fund assets are in ETFs and mutual funds with low costs but only 1% of assets are in ETFs and mutual funds with Attractive holdings. This discrepancy is astounding. Figure 1: Allocation of Fund Assets By Holdings Quality and By Costs Sources: New Constructs, LLC and company filings Two key shortcomings in the ETF and mutual fund industry cause this large discrepancy: A lack of research into the quality of holdings. A lack of high-quality holdings or good stocks. With about twice as many funds as stocks in the market, there simply are not enough good stocks to fill all the funds. These shortcomings are related. If investors had more insight into the quality of funds’ holdings, I think they would allocate a lot less money to funds with poor quality holdings. Many funds would cease to exist. Investors deserve research on the quality of stocks held by ETFs and mutual funds. Quality of holdings is the single most important factor in determining an ETF or mutual fund’s future performance. No matter how low the costs, if the ETF or mutual fund holds bad stocks, performance will be poor. Costs are easier to find but research on the quality of holdings is almost non-existent. Figure 2 shows investors are not putting enough money into ETFs and mutual funds with high-quality holdings. Only 94 out of 6706 (1% of assets) ETFs and mutual funds allocate a significant amount of value to quality holdings. 99% of assets are in funds that do not justify their costs and over charge investors for poor portfolio management. Figure 2: Distribution of ETFs & Mutual Funds (Count & Assets) By Portfolio Management Rating (click to enlarge) Source: New Constructs, LLC and company filings Figure 3 shows that investors successfully find low-cost funds. 69% of assets are held in ETFs and mutual funds that have Attractive-or-better rated total annual costs , our apples-to-apples measure of the all-in cost of investing in any given fund. Out of the 6706 ETFs and mutual funds we cover, 1524 (69% of assets) earn an Attractive-or-better Total Annual Costs rating. Clearly, ETF and mutual fund investors are smart shoppers when it comes to finding cheap investments. But cheap is not necessarily good. The PowerShares S&P SmallCap Utilities Portfolio ETF (NASDAQ: PSCU ) gets an overall predictive rating of Very Dangerous because no matter how low its fees (0.32%), we expect it to underperform because it holds too many Dangerous-or-worse rated stocks. Low fees cannot boost fund performance. Only good stocks can boost performance. Figure 3: Distribution of ETFs & Mutual Funds (Count & Assets) By Total Annual Costs Ratings (click to enlarge) Source: New Constructs, LLC and company filings Investors should allocate their capital to funds with both high-quality holdings and low costs because those are the funds that offer investors the best performance potential. But they do not. Not even close. Figure 4 shows that less than half (49%) of ETF and mutual fund assets are allocated to funds with low costs and high-quality holdings according to our Predictive Fund Ratings, which are based on the quality of holdings and the all-in costs to investors. Figure 4: Distribution of ETFs & Mutual Funds (Count & Assets) By Predictive Ratings (click to enlarge) Source: New Constructs, LLC and company filings Investors deserve forward-looking ETF and mutual fund research that assesses both costs and quality of holdings. For example, the PowerShares KBW Property & Casualty Insurance Portfolio ETF (NYSEARCA: KBWP ) has both low costs and quality holdings. Why is the most popular fund rating system based on backward-looking past performance? We do not know, but we do know that the transparency into the quality of portfolio management provides cover for the ETF and mutual fund industry to continue to over charge investors for poor portfolio management. How else could they get away with selling so many Dangerous-or-worse rated ETFs and mutual funds? John Bogle is correct – investors should not pay high fees for active portfolio management. His index funds have provided investors with many low-cost alternatives to actively managed funds. However, by focusing entirely on costs, he overlooks the primary driver of fund performance: the stocks held by funds. Investors also need to beware certain Index Label Myths . Research on the quality of portfolio management of funds empowers investors to make better investment decisions. Investors should no longer pay for poor portfolio management. Disclosure: David Trainer and Blaine Skaggs receive no compensation to write about any specific stock, sector or theme.