MSFT - DGRW: Big Dividends May Not Beat The Market

2023-12-13 20:10:14 ET

Summary

• The WisdomTree US Dividend Growth ETF focuses on EPS growth and is weighted by absolute dividends paid, but may struggle to generate alpha.
• I calculate a 7% upside potential to 2024 on consensus price targets.
• The portfolio has a PE of 16x on consensus estimates for 1.8x PEG ratio.

Summary

How to generate alpha or beat the market is the focus of many funds and ETFs. The WisdomTree U.S. Quality Dividend Growth Fund ETF ( DGRW ) utilizes a stock selection strategy based on EPS growth and is weighted by absolute dividends paid that has at least met market returns. However, in my view, may continue to fail in its endeavor to generate alpha.

Performance

The 10-year-old ETF has beaten the Vanguard Dividend Appreciation Index Fund ETF ( VIG ), which is more dividend growth-focused and has generally kept pace with the SP 500 ( SPX ) except in the post-pandemic over-earning period. It is important to remember that this is not a dividend-seeking ETF, and its yield is similar to or lower than the SP500 at under 2%.

The Strategy

This ETF does not seek high dividend yields or dividend growth. Its primary selection focus is based on quality EPS growth that factors in ROE and ROA metrics to select from a 300-company universe. The dividend factor comes in the portfolio weighting process i.e. of the stocks selected the largest positions go to those with the biggest absolute dividend payment. This is why Microsoft ( MSFT ) is substantially larger than Apple (AAPL). However, EPS growth can override dividends, as seen in the case of Nvidia ( NVDA ).

Holding Composition

The ETF has almost 300 stocks with Tech exposure, about the same as in the SP500 due to an overweight in Microsoft. The consumer defensive or staples and industrial sector are overweight, while higher dividend yielding sectors such as real estate, energy and utilities are underweight vs the SP500. It appears that the ETFs weighting methodology reduced EPS growth and dividend yield.

Portfolio Upside

I calculated the potential upside of DGRW using consensus price targets for 76% of the AUM. The weighted and average potential return is not very exciting at 7% to 8% for YE24 estimates. The ETF will rebalance at the start of 2024 and lower growth stocks may lose preponderance, but it will be difficult to cut Microsoft or Apple. The estimated dividend yield of 1.8% is not a reason to own the fund in my view.

EPS vs DPS Growth

Given the focus on EPS growth weighted for dividends I calculated the growth rate of both metrics using consensus estimates. I find that the ETF has a 20% estimated EPS growth for 2024, up considerably from 2023 while DPS growth rises to 8%. The future composition of the ETF may suffer if DPS growth in key holdings is higher than EPS, which may cause a reduction in exposure to higher-growth stocks. In my view, the stock selection process has flaws vs its growth goals.

Valuation

To get a sense of valuation I conducted a PEG (PE to EPS Growth) analysis. The rule of thumb is that a ratio of 1x or less is considered cheap i.e. growth is aligned with valuation. Using consensus estimates, I calculated the portfolio has a 1.8x PEG ratio for YE24 using average EPS growth in the YE24-25 period. I adjusted some stocks that are in recovery mode such as Lockheed ( LMT ), Cisco ( CSCO ), and Wells Fargo ( WFC ). In my view this is not an expensive portfolio, but can it surprise on earnings or warrant a greater multiple?

Conclusion

I rate the DGRW a Hold. In my view, this strategy may have difficulty in beating the SP500 given a portfolio bias for larger absolute dividend-paying stocks vs EPS growth. At the same time, while this is not an expensive portfolio, I’m not confident it can surprise on earnings or warrant a greater multiple.

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