DGRW - DGRW/QGRW: A Dynamic Duo For Maximizing Returns?

2023-09-18 16:30:47 ET

Summary

• DGRW is a well-established dividend-oriented fund from WisdomTree whose performance has ranked fifth-best in its category this year. QGRW is a newer offering, selecting 100 high-quality growth stocks.
• This article explores the possibility of combining the two ETFs in equal weight and evaluates the combined portfolio's diversification, volatility, growth, valuation, yield, and quality features.
• I'll also compare DGRW/QGRW with SCHD/SCHG, a pairing I previously determined could potentially outperform the S&P 500 while offering investors greater flexibility to overweight a particular style.
• I determined that the DGRW/QGRW pairing is more of a "growth-lite" portfolio suitable for moderately aggressive investors with no immediate income needs. However, it's still a solid choice because of its focus on high quality stocks. As I'll demonstrate, ETFs that score weak in that area tend to underperform.

Article Purpose

In June, I wrote an article questioning whether Schwab's SCHD and SCHG were the ultimate growth and valuation combination, concluding that the approach allowed for greater flexibility and a solid shot at outperforming an S&P 500 Index ETF. Today, I want to look at another two-ETF solution that combines the WisdomTree U.S. Quality Dividend Growth Fund ( DGRW ) and the WisdomTree U.S. Quality Growth Fund ( QGRW ), a new ETF with a December 2022 launch date. Below, you'll find the results of a fundamental analysis that considers holding DGRW and QGRW in equal weight, an examination of the portfolio's diversification, and what type of investor this two-ETF solution is designed for. I hope you enjoy the read.

Strategy Discussion

DGRW tracks the WisdomTree U.S. Quality Dividend Growth Index, selecting roughly 300 U.S. companies based on earnings growth and three-year return on assets and equity. DGRW weights constituents based on aggregate future one-year dividends, which is the product of a company's outstanding shares and dividends per share. It is a modified market-cap-weighting scheme, as larger companies still have substantial influence. Apple ( AAPL ) and Microsoft ( MSFT ) are DGRW's top two holdings, yet their yields are minimal. As a result, DGRW is more growth-oriented than other dividend funds like SCHD. In addition, the Index reconstitutes annually in December, applying a 7% weight limit to individual securities and a 20% weight limit to sectors (10% for Real Estate).

QGRW tracks the WisdomTree U.S. Quality Growth Index, selecting 100 U.S. companies from the top 500 by market capitalization based on a composite score of two equally weighted factors measuring growth and quality. Growth is assessed by applying a 50% weighting to its median analyst earnings growth forecast, a 25% weighting to its trailing five-year EBITDA, and a 25% weighting to its trailing five-year sales growth. Quality is assessed by a company's trailing three-year return on equity and assets, the same as DGRW. The Index reconstitutes semi-annually after the second Friday in June and December, is market-capitalization-weighted, and applies a 15% weight limit to individual securities. In addition, the collective weights of constituents exceeding 5% should not exceed 50% each quarter, at which point the collective weight would reduce to 40%. Please note that there are no sector weighting constraints.

Based on these descriptions, an investor holding DGRW and QGRW should expect a high-quality portfolio that leans toward growth. The lack of sector weighting constraints suggests that QGRW has a concentration issue, which could lead to substantial outperformance or underperformance in a given year. Pairing it with DGRW should alleviate this issue, but the two ETFs are not opposites. Unlike SCHD and SCHG, which have a 3% overlap by weight, DGRW and QGRW have a 28% overlap by weight.

Composition and Fundamentals

Sector Exposures

The following table highlights sector exposures for DGRW, QGRW, SCHD, and SCHG. Notice how there are many similarities between QGRW and SCHG. The exposures to eight sectors (Consumer Staples, Energy, Industrials, Technology, Materials, Real Estate, Communication Services, and Utilities) are within a couple of percentage points. The main difference is that QGRW overweights Consumer Discretionary and Financials by 3.44% and 4.10% but underweights Health Care by 4.68%. Based on this, I expect QGRW to be more risky with a higher five-year beta.

DGRW is also riskier than SCHD, as suggested by its 29.56% allocation to Technology stocks. Of course, this favorable composition has led to a 12.31% YTD gain through August, the fifth-best among the 62 U.S. Dividend ETFs I track. Since January 2019 (a little less than five years ago), it's also the third-best dividend fund behind the Siren DIVCON Leaders Dividend ETF ( LEAD ) and the First Trust Rising Dividend Achievers ETF ( RDVY ). Nearly all the top-performers are low-yielding ETFs, but SCHD is the exception, which explains why it's caught the attention of so many dividend investors. It's solid on income and capital appreciation, whereas DGRW is mainly capital appreciation.

DGRW Fundamentals By Company

The following table highlights selected fundamental metrics for DGRW's top 25 holdings, totaling 75% of the portfolio. I've also included summary metrics for SCHD and SPY in the bottom rows. Notice that, despite DGRW's weighting constraints, it's still somewhat concentrated, with 58.84% of assets in its top 25 compared to 45.21% for SPY. However, SCHD is the most concentrated of the three, with 79.40% in its top 25.

I want to make three observations:

1. DGRW, SCHD, and SPY are all high-quality funds based on their strong 9.44/10, 9.48/10, and 9.35/10 Profit Scores, which I calculated using individual Seeking Alpha Profitability Grades. Specifically with SPY, the idea that a market-cap-weighted large-cap fund needs a complex quality screen is a stretch. However, many rules-based dividend funds emphasize yield and valuation while letting quality suffer, and the results haven't been that great. To illustrate, consider these profit scores and total returns since January 2019 for these five other dividend-oriented funds alongside DGRW, SCHD, and SPY:

• Vanguard High Dividend Yield ETF ( VYM ): 8.76/10, 59.31%
• iShares Core Dividend Growth ETF ( DGRO ): 8.97/10, 74.41%
• SPDR S&P Dividend ETF ( SDY ): 8.46/10, 54.86%
• iShares Select Dividend ETF ( DVY ): 7.65/10, 49.56%
• ProShares S&P 500 Dividend Aristocrats ETF ( NOBL ): 8.77/10, 69.77%
• WisdomTree U.S. Dividend Growth ETF ( DGRW ): 9.44/10, 92.85%
• Schwab U.S. Dividend Equity ETF ( SCHD ): 9.48/10, 84.86%
• SPDR S&P 500 ETF ( SPY ): 9.35/10, 94.18%

To be clear, picking ETFs isn't as easy as finding the ones with the best profit scores. There are always exceptions, especially with less-diversified funds concentrated in favorable sectors. The First Trust Rising Dividend Achievers ETF ( RDVY ) is a prime example, scoring 8.72/10 on profit with a 95.92% total return since January 2019. RDVY holds only 50 stocks, is 40% Financials, and overweighted Technology over the last few years, so it's not suited for defensive investors. However, I recommend keeping the profit score relatively high for well-diversified ETFs to avoid long-term underperformance. That's intuitive to most investors, but "quality" or "profit" scores aren't often published by third-party providers, leaving many in the dark.

2. DGRW and SCHD share reasonably low five-year betas (0.93 and 0.91), but that's about where the similarities end. As indicated by the revenue and earnings growth metrics, DGRW is closer to being a blended fund than a value one. It features almost 4% more estimated earnings per share growth than SCHD, but it trades at 22.72x forward earnings vs. 17.00x or SCHD. Also, DGRW's constituents yield just 2.19% on a weighted average basis, so after subtracting the fund's 0.28% expense ratio, investors are left with 1.91%, nearly identical to the fund's trailing 1.90% yield. In contrast, SCHD is better suited for income investors. Its components yield 3.72% or 3.66% after fees. With its members growing dividends by 10.65% over the last five years, it's easy to see why the fund is so popular.

3. DGRW is better diversified at the company level, with 58.84% of assets in its top 25 holdings compared to 79.40% for SCHD. Also, DGRW has assets in 101 industries vs. 49 for SCHD, so it appears less in need of a complementary ETF. Remember that SCHD's fundamentals will generally look attractive, in part, because it only holds 100 stocks. It's more challenging to do that with 300- or 500-stock funds, but that's the price you pay for diversification.

Overall, DGRW ranks better on diversification and growth than SCHD, which lends well to recent market movements. SCHD has the edge on yield and, in turn, valuation. It's done an exceptional job for a value fund, but its weak growth rates have led to stalled returns over the last two years.

QGRW Fundamentals By Company

With a two-ETF portfolio, the funds should complement each other well. QGRW and SCHG are both in the growth category, so I initially expect the WisdomTree portfolio to be somewhere between blend and growth, while Schwab's is a blend fund similar to SPY. Let's take a look at the fundamentals to find out.

QGRW and SCHG look similar on nearly all metrics. Both have weighted average market capitalizations above $1 trillion, indicating high allocations to mega-cap stocks like Apple, Microsoft, Alphabet ( GOOGL ), Nvidia ( NVDA ), and Amazon ( AMZN ). Estimated sales and earnings growth is within a percentage point and each trade at about 33x forward earnings. QGRW's 9.74/10 Profit Score is better, but SCHG's 9.60/10 is still solid, proving that large-cap market-cap-weighted ETFs don't always need dedicated quality screens. SCHG screens include forward P/E, estimated operating earnings growth, trailing P/B, indicated dividend yield, trailing revenue growth, and trailing earnings growth.

Creating 2-ETF Portfolios: WisdomTree vs. Schwab

Let's see what happens when we combine WisdomTree's DGRW and QGRW in equal weight. I've listed the fundamentals for this hypothetical portfolio's top 25 holdings below, with comparisons to SCHD/SCHG and SPY at the bottom.

1. As a reminder, DGRW and QGRW had 58.84% and 77.74% of assets in their top 25 holdings, whereas combining them resulted in a 57.48% concentration. This diversification improvement is only marginal because there is a 27.95% overlap by weight between the two funds. In contrast, SCHD and SCHG overlap only 2.68%, and the combined portfolio has 60.21% in its top 25. Recall how each has about 80% concentration, so it's a big improvement.

2. We see the higher growth profile I anticipated for WisdomTree's ETFs based on their combined 9.86% and 10.66% estimated sales and earnings per share growth rates, but it's only between 1-1.5% more than Schwab's products. Some relates to Nvidia, which the DGRW/QGRW portfolio overweights by 1.03%. Its 50%+ estimated EPS growth rate is an outlier and could already be priced in via its 40.55x forward earnings multiple. However, most of DGRW/QGRW's higher growth relates to what it doesn't hold. Consider the growth rates of these six stocks, which have a combined 7.52% weighting in DGRW/QGRW but are excluded in SCHD/SCHG:

The average estimated sales and earnings per share growth rates are 2.47% and 4.30%, so they don't belong in growth-oriented funds. However, they are resilient in market downturns. Consider their average 3.95% loss in 2008 compared to SPY's 36.81% decline.

More recently, in 2022, these six stocks declined by 7.93% on average compared to SPY's 18.17%, so there's a practical reason to include them in your portfolio. It's just a matter of risk tolerance.

3. The gross dividend yield for DGRW/QGRW is 1.39%, or 1.11% after fees. It's actually lower than that today, as QGRW does not yet pay a dividend. However, its summary prospectus states that the fund "intends to make distributions that may be taxed as ordinary income, qualified dividend income, or capital gains." Regardless, SCHD/SCHG yields 2.06%, and its constituents have grown dividends by an annualized 8.35% over the last five years. It is a better solution than SPY for income investors, as it doesn't sacrifice any key metric other than diversification.

What About DHS?

So far, we have seen how DGRW is a poor solution for income investors, but it is one of the better dividend-oriented funds to own in bull markets from a total return perspective. Therefore, I also want readers to consider substituting DGRW with the WisdomTree U.S. High Dividend Fund ( DHS ), which yields 4.21%. Below are the results for that combination.

As expected, this portfolio's gross yield improved to 2.55% or 2.22% after fees. It's slightly better than SCHD/SCHG's 2.06%, and the portfolio has a somewhat lower growth profile. However, that's not the main issue. The profit score dipped to 9.01/10 due to DHS's weaker 8.28/10 score, and to reiterate my prior point, this could make the portfolio vulnerable. In 2008, DHS declined by 38.90%, and although it recorded a 7.95% gain last year, that was mainly due to favorable sector allocations. I anticipated this in January 2022 , but I relied on fundamental analysis and a belief in rising inflation to do so. You may not be interested in following these changes so closely, so it's probably not the best approach.

Investment Recommendation

In this article, I considered the pros and cons of holding WisdomTree's DGRW and QGRW in equal combination. I found that dividend yield was a significant sacrifice, and the mix wasn't as efficient as I would like, mainly because they don't follow opposite value and growth styles. However, the quality was excellent, as indicated by a 9.59/10 profit score. While substituting DHS for DGRW resulted in a better dividend yield, profitability suffered, and this is not a strategy I recommend. Investing in high-quality companies is the key to long-term success; while DGRW and QGRW share this feature, DHS does not.

Still, I prefer Schwab's SCHD/SCHG combination because of its better dividend yield and dividend growth combination, lower fees, and similar 9.54/10 profit score. Its estimated sales and earnings growth rates are 1-2% less than DGRW/QGRW, but it trades about 3-4 points less on forward earnings and trailing cash flow, so it's an acceptable sacrifice. However, that's only my preference, and I believe the DGRW/QGRW combination would work reasonably well for the moderately aggressive investor over the long run. I hope you found this information helpful, and if you would like to know how other two-fund ETF combinations match up against these, please feel free to suggest them below. Thank you for reading.

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