DIVO - DIVO: Strong Dividend ETF 5.2% Yield Market-Beating Returns

Summary

• DIVO is an ETF investing in dividend-paying U.S. equities with strong fundamentals.
• The fund focuses on high-quality companies, yield 5.2%, and has a strong performance track-record.
• An overview of the fund follows.

Author's note: This article was released to CEF/ETF Income Laboratory members on January 31st.

I last covered the Amplify CWP Enhanced Dividend Income ETF ( DIVO ), an actively-managed dividend income ETF, in May 2022. In that article, I argued that DIVO's high-quality holdings, above-average yield, strong dividend growth track-record, and reasonably good potential capital gains and total returns made the fund a buy. DIVO has moderately outperformed since then, as expected.

DIVO's fundamentals have slightly degraded since, with a marginally lower dividend yield, and with a narrower valuation gap vis a vis the S&P 500. Although fundamentals have worsened, these remain reasonably good, with the fund offering investors diversified exposure to high-quality companies, an above-average 5.2% dividend yield, and good performance track-record. DIVO remains a buy, although slightly less so than in the past.

DIVO - Basics

• Investment Manager: BlackRock
• Dividend Yield: 5.21%
• Expense Ratio: 0.55%
• Total Returns 5Y: 9.92%

DIVO - Overview and Investment Thesis

DIVO's investment thesis is quite simple, and rests on the fund's diversified high-quality holdings, above-average 5.2% dividend yield, and good performance track-record. Let's have a look at each of these three points.

Diversified High-Quality Holdings

DIVO is an actively-managed large-cap U.S. equity ETF.

DIVO invests in 20-25 large-cap U.S. equities from all relevant industry segments. DIVO is actively-managed, so security selection and weights are an active investment decision, ultimately dependent on the fund's management team.

DIVO focuses on large-cap U.S. equities, with a strong emphasis on quality , dividend growth, earnings growth, and other assorted fundamental factors. Weights seem to depend on said factors as well, although the fund is very close to being equal-weighted right now. DIVO's largest holdings are as follows.

As can be seen above, DIVO's largest holdings are all large-cap U.S. equities of reasonably good quality. Specifically, DIVO excludes some of the lower-quality large-cap U.S. equities, including Tesla ( TSLA ) and Facebook ( META ). These might be strong investments on valuation or growth grounds, but they are definitely not high-quality companies like Microsoft ( MSFT ) or Procter & Gamble ( PG ).

DIVO's high-quality holdings are generally able to sustain their earnings and dividends through downturns and recessions, at least more than the average large-cap U.S. equity. Focusing on these companies reduces portfolio risk and volatility while increasing dividend sustainability, all important benefits for the fund and its shareholders.

DIVO provides investors with exposure to all relevant equity industry segments. Industry weights are an active investment decision, dependent on fundamental factors and management views. DIVO is generally overweight old-economy industries, including industrials and energy, while being underweight tech, as is common for dividend equity funds. Currently, the fund is also overweight healthcare, likely due to management bullishness plus strong industry fundamentals.

From what I've seen, and based on previous coverage, DIVO's industry exposures have led to strong gains in the past. As an example, the fund's overweight energy position and underweight tech position were both a positive in 2022, and were at least partially responsible for the fund's outperformance during said year.

DIVO's high-quality holdings are safer than average, while the fund's investment strategy has led to strong returns in the past, a solid combination. Although there is no guarantee that performance will remain strong in the future, past results are quite encouraging.

Above-Average 5.2% Dividend Yield

DIVO tends to invest in companies with above-average yields, and sells covered calls on a portion of its holdings. These strategies serve to boost the fund's yield to 5.2%, reasonably good on an absolute basis, moderately higher than the average U.S. equity index fund, and slightly higher than most U.S. dividend equity funds. It is a good, above-average yield, albeit lower than that of most CEFs, BDCs, mREITs, and several other niche asset classes / funds.

DIVO's above-average dividend yield is an important benefit for the fund and its shareholders, and particularly beneficial for income investors and retirees.

On a slightly more negative note, DIVO's dividend growth track-record is, at best, complicated. DIVO's dividends have grown by about 5.0% annually since inception, but dividends are volatile, and growth uneven. Importantly, dividends decreased last year, by 6.5%. I'm not sure why they decreased, but minor changes in the fund's portfolio seems like the most likely explanation (DIVO's underlying holdings did not slash their dividends, nor did the fund's assets decline, nor did covered call strategies deliver less income in the past).

In my opinion, as DIVO's dividends have grown since inception, the fund's dividend growth track-record remains fair or reasonable. The volatility and recent cut does mean that future growth is far from certain, and that lower dividends in 2023 are possible.

As a final point, and by my estimates, DIVO sells covered calls for something like 5% - 25% of the total value of the fund, on individual stocks. The exact percentages, as well as the individual stocks chosen, are both investment decisions, at management's discretion. Changes in covered call strategies could impact fund dividends moving forward too.

Good Performance Track-Record

DIVO's performance track-record is reasonably good, with the fund slightly outperforming the S&P 500 since inception, and for most relevant time periods. The fund's performance has been particularly strong these past twelve months, due to savvy industry positioning: overweighting energy while underweighting tech. DIVO has also outperformed relative to most U.S. dividend equity index funds since inception and for most relevant time periods too.

Although the figures above are accurate, I feel they overstate the consistency and strength of DIVO's performance. It is quite normal for the fund to underperform relative to the S&P 500, as was the case from 2020 to 2022.

At the same time, DIVO has only matched the performance of the S&P 500 since inception.

DIVO's performance track-record is good, and a benefit to the fund and its shareholders, but a relatively small one.

Overall Investment Thesis

Although DIVO does not excel in any particular metric, it does compare favorably to its peers in several, and the combination seems quite potent.

Risks are somewhat below-average, due to its high-quality holdings.

Income is above-average, due to focusing on high yield stocks plus selling covered calls on a portion of its holdings.

Total returns are also above-average, mostly due to savvy industry positioning.

DIVO compares favorably to its index and peers in most relevant metrics, making a strong, well-balanced fund and investment opportunity. In my opinion at least.

With the above in mind, let's have a look at DIVO's risks and downsides.

DIVO - Risks and Downsides

Concentrated / Undiversified Portfolio

DIVO's portfolio is significantly smaller than average. U.S. equity index funds tend to invest in hundreds, if not thousands, of companies. Actively-managed U.S. equity funds tend to invest in hundreds of companies, although some do have smaller, more targeted portfolios with only dozens of holdings. DIVO's small, concentrated portfolio increases risks, volatility, and the potential for significant losses and underperformance from losses in a specific holding, and is the fund's most significant downside. In my opinion, DIVO is concentrated enough that small position sizes are ideal, in the 5% - 10% range max.

From what I've seen, DIVO's concentration has not led to losses or underperformance in the past, but that might not be the case moving forward.

Slightly Reduced Potential Capital Gains

DIVO sells covered calls on around 5% - 25% of its holdings. Doing so reduces potential capital gains by a similar, probably somewhat lower, percentage. As DIVO sells calls on a relatively small portion of its holdings, potential capital gains remain reasonably strong. Savvy security selection, industry exposures, and other investment decisions could, potentially, more than make up for any potential capital gains shortfall.

DIVO itself has seen below-average capital gains since inception, in-line with expectations. On the other hand, I'm not certain that these results were due to the fund's covered call strategy. DIVO saw almost identical capital gains to the Vanguard High Dividend Yield ETF ( VYM ), which does not sell covered calls, but which does have broadly similar industry exposures.

In any case, I'm certain that DIVO's covered call strategy slightly reduces the potential capital gains the fund can experience, a negative for the fund and its shareholders. Do bear in mind, the reduction is small, so this is a minor negative, and the fund should see good, positive capital gains long-term.

DIVO - Valuation Analysis

DIVO focuses on dividend-paying U.S. equities, with somewhat below-average valuations. DIVO itself has a moderately lower P/E ratio than the S&P 500, but the exact same PB. DIVO has a slightly higher P/E ratio than VYM, significantly higher P/B ratio.

In general terms, although DIVO's valuation is definitely a bit cheaper than average, it is not cheap enough to be considered an important benefit or advantage for the fund. DIVO focuses on industries with below-average growth prospects, so cheap valuations are to be expected. At the same time, the fund is somewhat more expensive than most dividend equity funds. One could argue that a lower P/E relative to the S&P 500 is significant enough as to be considered a benefit, but the overall situation does not seem clear enough / important enough to me.

Conclusion

DIVO's high-quality holdings, above-average 5.2% dividend yield, and good performance track-record, make the fund a buy.

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