SET Monthly Issue September 2016
DRIVEN BY DIVIDENDS
Sector investing is smart. It shields us from swoons, like we saw in the energy business a few years ago, and like we saw in financials and financial services earlier this year. Harnessing your sector ETFs to an asset allocation strategy that supports your investing goals is a foundation for success.
So is thoughtful diversification. This is why we recommended an ETF like our Aberdeen Chile Fund (CH) as a special opportunity that, in most cases, doesn’t warrant a significant share of your portfolio… but is a great way to add some extra income.
The Aberdeen Chile Fund pays a dividend with an 8.83% yield… a welcome change from the skimpy returns of bond funds.
But for income that’s less volatile, the road leads back to a familiar source of wealth, and that’s the world of dividend stocks.
This search for a safer source of income, where an ETF can play a larger role in your portfolio than a specialized issue such as The Aberdeen Chile Fund ETF, is why this month’s recommendation is the Vanguard High Dividend Yield ETF (VYM).
THE STALWARTS OF DIVDEND STOCKS
This ETF is a sound selection if you’re looking to play it safe with your income. It mirrors the FTSE High Dividend Yield Index, which is made up of all U.S. dividend-paying stocks with one notable exception… there are no Real Estate Investment Trusts (REITs).
The holdings are determined by two factors… the dividend yield and market cap. This builds on a portfolio of blue chip stocks such as ExxonMobil, General Electric, and Microsoft.
THE CASE FOR DIVIDEND STOCKS
Dividend-paying stocks have turned in a stronger long-term total return performance than stocks that don’t pay dividends.
This isn’t a short-term event… look at this from an 87-year perspective.
Total returns, averaged for annual performance, were 10.4% stronger from 1927-2014.
Dividend stocks do better than the overall market when interest rates are going up, and they also weather the storms of market volatility.
One of the benchmarks for measuring volatility is the VIX, which measures market expectations for near-term volatility in the S&P 500 stock index option prices.
Months when the VIX is up more than 40%, which we often see when there’s a broad market decline, stocks that pay growing dividends historically outperform stocks that don’t pay dividends by close to 3%.
This raises another issue… whether or not the dividends grow. Some stocks that pay dividends don’t increase them… not good, but not as bad as a stock that cuts its dividend.
When a cut happens, it’s an alarm bell signaling trouble ahead. Dividend cuts almost always trigger a sharp drop in the share price.
There are rumblings that the major energy companies could be stretching themselves financially to pay their dividends. This is not exactly a probable scenario, but something to keep in mind… big, safe, solid companies can falter. Dividend distributions are not guaranteed, and the future is never a sure thing.
But what about right now? Are we looking at the kind of market conditions that make sense for an investment in dividend stocks? We can’t help but wonder…
ARE DIVIDEND STOCKS OVERPRICED?
It’s a good question to ask. The entire market is expensive right now, and dividend stocks in particular, which historically have always commanded a premium price, are usually in the high rent district.
Curiously, right now they’re not. This provides us with a rare opportunity to make a good deal on a quality investment. It also gives us a way to minimize volatility.
Last month, we placed a high degree of importance on lessening the sting of volatility when we recommended the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV).
The Vanguard High Dividend Yield ETF gives you the same kind of protection.
What kind of a price do you pay? A good way to measure this is to look at the P/E ratio, the price earnings ratio.
Right now, the overall market P/E is 18. The P/E for The Vanguard High Dividend Yield ETF is 17.
And the actual dividend yield is 3.31%.
WHY WE LIKE THIS PARTICULAR DIVIDEND FUND
It’s not exactly front-page news that Vanguard ETFs are where investors typically get the best fees. Expenses for The Vanguard High Dividend Yield ETF are 0.09%. This is about one quarter of the category average.
The fund has been around since the fall of 2006. It is one of the largest ETFs, with more than $15 billion in assets, which in itself doesn’t provide investors with any benefits. But it underscores the thirst for income that’s in the equity market right now with bond yields so low.
The ETF squeaked out a modest return of 0.28% in 2015. YTD in 2016, it is up 8.69%.
WHAT ABOUT THE CHANCE OF DIVIDEND CUTS?
Ever since GE announced a dividend cut of 10 cents a share in 2009, investors in supposedly rock solid dividend stocks have been skittish. And with good reason.
The types of stocks in this ETF are not exactly leading candidates for dividend cuts. But there are no guarantees.
In our August update, we shared our concerns about productivity, and how declines in labor productivity could hurt a company’s ability to raise prices, increase margins, and drive higher profits.
When earnings skid dramatically, there may not be enough money in the bank for a company to pay the dividend.
But these problems tend to be the exception to the rule. Even when the market plunged in 2008, the majority of the blue chip stocks that are considered Dividend Aristocrats, which this ETF includes, did not cut the dividend.
So when you look at the ETF, you see a lineup of solid performers. The top five holdings and percentage weight for VYM:
| Company Name | Sector | % Weight | ||||
| Microsoft Corp | Technology | 4.46% | ||||
| Exxon Mobil Corp | Energy | 4.44% | ||||
| Johnson & Johnson | Health Care | 3.81% | ||||
| General Electric Co | Diversified Industrial | 3.34% | ||||
| AT&T Inc. | Telecom | 3.05% | ||||
| 09/03/16 | ||||||
A CLOSER LOOK AT THE TOP 5 HOLDINGS
The performance of Microsoft, the #1 stock tracked by the ETF, has been a mystery. 2016 has been tough for the bellwether tech firm. The stock price is down 1.91% but it sells for a hefty premium… more than twice the market average. Microsoft pays a 2.68% dividend that has been growing for the past 12 years.
But Microsoft isn’t the only expensive stock in The Vanguard High Dividend Yield ETF.
Johnson & Johnson, Exxon Mobil, and General Electric all trade at P/E ratios well above the market.
When we analyzed the P/E ratios of the ETF’s top 25 holdings, we noted that 18 trade above the market average and 7 trade below. It’s a reminder of the price investors pay for both income and quality.
And when we analyzed YTD return, we tallied up 22 winners and 3 losers. The other losers alongside Microsoft are Wells Fargo & Co. and J.P. Morgan Chase.
A DIVERSIFIED LINEUP OF INDUSTRIES
Here’s how sectors within the ETF break out…
- Consumer Goods: 15.6%
- Financials: 13.9%
- Tech: 13.4%,
- Industrials: 12.4%,
- Oil And Gas: 10.5%
THE ROLE OF VMY IN YOUR PORTFOLIO
Income. This is a foundational, conservative ETF. It is not the income sweetener of an investment like our Chile fund, but it is a workhorse, a source of baseline income.
It is also a buy and hold position… an ETF we will probably never want to sell.
Trade Alert
Buy: Vanguard High Dividend Yield ETF (NYSE: VYM) up to $77.00
Recent Price: $73.47
Price Target: $82.00
Stop Loss: $65.50
YEAR TO DATE SECTOR PERFORMANCE
| Consumer Discretionary | XLY | +3.48% | |||
| Consumer Staples | XLP | +8.58% | |||
| Energy | XLE | +14.52% | |||
| Financial Services | XLFS | +1.57% | |||
| Financials | XLF | +3.11% | |||
| Health Care | XLV | +0.86% | |||
| Industrials | XLI | +11.17% | |||
| Materials | XLB | +13.43% | |||
| Real Estate | XLRE | +7.72% | |||
| Technology | XLK | +10.55% | |||
| Utilities | XLU | +14.67% |
PORTFOLIO UPDATES
. . . . iShares MSCI Emerging Markets Minimum Volatility ETF $EEMV – BUY
The global markets have been throwing more volatility at this ETF than any of us would like to see. Even emerging market stocks with low volatility compared to broader market indices have been struggling.
EEMV edged up to $54.69 following our buy recommendation of $54.02, but over the past few weeks has given up ground. While the ETF continues to trade in a fairly narrow range, income investors are being looked after with a recent yield of 2.44%.
Buy up to $59.25. The price target is $76.00.
. . . . Vanguard Information Technology ETF $VGT – HOLD
Tech has been on a tear. The ETF is up 12% since our buy recommendation in July.
The sector has been consolidating gains for the past month. It has hit a 52-week high and we are anticipating more gains ahead.
The price target is $127.00.
. . . . First Trust ISE-Revere Natural Gas Index Fund $FCG – BUY
Natural gas prices have edged up since our buy recommendation, and the ETF is up 2% since June. Trading for the past few weeks has reflected a gradual increase, with the fund coming off a low of $24.56 on August 10th.
The buy up to price for the ETF is $26.70 and the price target is $37.00.
. . . . PowerShares S&P SmallCap Energy ETF $PSCE – BUY
We have been pleased with the performance of this ETF over the past month. It is up 10% since our recommendation, and is approaching our buy up to price is $17.50.
. . . . First Trust NASDAQ Community Bank Index Fund $QABA – HOLD
It’s been a good month for QABA, after giving up some gains earlier this summer.
The ETF’s largest position, Signature Bank, is holding back an even stronger performance. Signature missed analysts’ Q2 earnings forecast and the stock has been in the doldrums, well off highs reached earlier in the year.
The price target for QABA is $46.00.
. . . . Aberdeen Chile Fund $CH – HOLD
The ETF continues to trade in a fairly narrow range, and remains well above the buy price of $5.73. The story on this ETF stays the same… high yield while we wait for the Chinese to ramp up their copper imports from Chile.
The price target is $11.00.
. . . . SPDR S&P Homebuilders $XHB – HOLD
The increases in new home construction keep on coming, and the upsurge in activity continues to benefit XHB.
The question mark surrounding the SPDR S&P Homebuilders ETF… will interest rate hikes hurt? We believe the possible impact of rate increases has been factored into the trading price, and that any setbacks will be minor.
The price target is $50.00. Continue holding.
. . . . Utilities Select Sector SPD $XLU – HOLD
Continue holding. Despite the fallback from recent highs, this ETF remains a solid defensive, long-term position.
Portfolio Changes
- This month we’re buying Vanguard High Dividend Yield ETF (VYM) up to $77.00.
Category: SET Monthly Issues
