XPH - A Diversified Equity-Income ETF Better Than The Rest: DVY

2023-05-29 10:57:56 ET

Summary

• iShares Select Dividend ETF offers high quarterly income checks, steady income growth, and broad diversification.
• Weak 3-month price change could be opening a smart buy entry for new capital.
• DVY could be a core position in an income-oriented portfolio, with targeted annualized total returns of +9% to +10% in the future.

For those wanting exposure to high quarterly income checks, with an investment holding broad diversification and steady dividend growth characteristics, iShares Select Dividend ETF ( DVY ) may be a sound choice to consider.

Intelligent risk-adjusted levels of diversification are the calling card I like best, owning U.S. blue chips with well above-average dividend yields vs. the prevailing S&P 500 rate.

This ETF held 106 positions on May 24th, 2023, and the Top 10 holdings represented just 17.6% of the fund. A lack of concentration in any one stock or sector is very desirable when an investor tries to reduce price and dividend payment risk over the long term. Below is a table of the Top 10 weightings. I would note I am currently bearish on Verizon ( VZ ) and AT&T ( T ) because of slowing wireless industry growth and excessive company debt levels. The good news is these two account for less than 4% of the whole fund. And, you will get the benefit of extraordinarily high cash yields (7.4% and 7.1% respectively) until their dividends are cut (my forecast).

The fund is not overly dependent on one sector of the economy to boom and generate its high dividend yield either. Utilities are the largest industry weighting, but this category is well diversified for exposure.

The BlackRock, Inc. ( BLK ) annual management expense is fair at 0.38%, albeit not the lowest you can find for an indexed ETF. Assets under management for the fund are $19.6 billion, meaning liquidity for traders and investors is excellent. And, the trailing dividend yield of almost 3.9% is far above the U.S. equity market "average" closer to 1.5%.

Performance Stats

The main reason I am writing on DVY today is it has underperformed the S&P 500 (heavily weighted toward Big Tech names) by a whopping -15% over the last three months. Below I am graphing iShares Select Dividend vs. a general U.S. blue-chip investment in the SPDR S&P 500 ETF ( SPY ), fixed-income vehicles iShares 7-10 Year Treasury Bond ETF ( IEF ) and iShares 20+ Year Treasury Bond ETF ( TLT ), your typical high-yielding equity sectors of the Utilities Select Sector SPDR ( XLU ), Vanguard Real Estate ( VNQ ), and Energy Select Sector SPDR ( XLE ), plus the dividend-growth idea SPDR S&P Pharmaceuticals ( XPH ).

Today's relative 3-month loss in DVY vs. SPY is nearly the greatest over the last decade and is roughly matching the July 2020 bummer, which proved an excellent time to buy this ETF. You can review the trailing 3-month total returns for both since 2013 below.

Since that point, DVY has bested the S&P 500 for performance during the end of the Tech 2.0 boom and bear market from January 2021. In a sense, this dividend-focused investment has been something of a defensive gem, when bought on the cheap at the right time.

And, its strong diversification characteristic has allowed the ETF to basically perform better than bonds and sector-focused funds over the last 10 years.

Dividend Story

DVY has paid $4.26 in dividends over the past 12 months for a trailing yield of 3.8% to 3.9% on the present $109-110 ETF price.

This yield is one of the top rates you can find from a diversified equity-income fund. 4% for a future cash distribution (assuming minor payout growth this year) runs circles around 90% of U.S. equities today.

Even better news is the dividend payout climbs over time as companies raise their payouts on economic growth and inflation increases in sales and profits. The quarterly payout has roughly doubled over 10 years, for a 7% increase each year as the typical compounded outcome.

This rate of cash distribution growth has been one of the highest and most consistent in the peer group. Only the growth-oriented Big Pharma sector and turnaround in the energy industry (on Russia's invasion of Ukraine) have beaten DVY over the last five years for dividend raises.

Final Thoughts

The tradeoff for upsized immediate income (cash yield) is less price appreciation potential over time. Companies that pay higher-than-normal yields are necessarily investing less in business growth. So, with inflation and economic expansion, total returns may not keep pace with the S&P 500 or NASDAQ 100 technology leaders in America.

But, if you are closer to retirement, greater upfront yield may be a priority. iShares Select Dividend has more going for it than a fixed-income bond investment (where dividend checks never rise), or the energy sector in long-term decline from green energy competition, or a standalone concentration in real estate, utilities, or prescription drug enterprises. If current savings and Treasury rates of 4% to 5% decline on lower inflation rates going forward, owing DVY's growth in cash payouts and likely rising underlying stock position value will be a huge relative winner vs. rolled fixed-income assets.

Recession risks are somewhat reduced with this ETF's diversified design, while upside in the dividend and ETF quote remains theoretically unlimited in a world of rising inflation (if such a scenario is our future).

From a technical trading perspective, most of the momentum indicators I track bottomed in March (green arrows on the chart below). The May price selloff is not being confirmed as a function of overly aggressive selling pressure. My read of the chart pattern is a price rebound could come at any moment.

Assuming the bear market on Wall Street resumes (which is highly probable in my view), it remains a possibility DVY will outperform the S&P 500, now heavily overweight high-beta and richly-priced Big Tech names. Purchasing iShares Select Dividend on further weakness makes perfect sense historically.

As part of your income-oriented portfolio, DVY could be considered as a core position, with targeted annualized total returns of +9% to +10% in the future. Starting from a higher dividend yield point in time, I suspect DVY will deliver improved overall gains vs. the last decade's +8.7% compounded for dividends and price appreciation. Price volatility may prove slightly greater than a bond investment, especially if you own it for just one or two years, but total returns should easily favor this ETF if you hold it for 5-10 years.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

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