ILCV - EPS: A Watered-Down Value Fund

2023-12-12 16:23:51 ET

Summary

• WisdomTree U.S. Earnings 500 Fund ETF invests in the 500 largest companies in the U.S. stock market, weighted based on earnings.
• The EPS ETF is less concentrated than the S&P 500 in the technology sector and shows more attractive valuation and quality metrics.
• EPS has outperformed other value ETFs, but it looks like a watered-down value fund.

EPS strategy

WisdomTree U.S. LargeCap Fund ( EPS ) was formerly known as WisdomTree U.S. Earnings 500 Fund ETF. It is a passively managed exchange-traded fund, or ETF, tracking the WisdomTree U.S. LargeCap Index. It started investing operations on 02/23/2007, has 504 holdings, a total expense ratio of 0.08% and a distribution yield of 1.77%. Distributions are paid quarterly.

As described by WisdomTree , the underlying index “ measures the performance of earnings-generating companies within the large-capitalization segment of the U.S. Stock Market .”

The index includes the 500 largest companies ranked by market capitalization in the WisdomTree U.S. Total Market Index and it is weighted based on earnings. Earnings are the product of market capitalization and earnings yield (the inverse of P/E ratio), so we can consider it as a value index adjusted by market capitalization. As a consequence, mega cap companies are privileged over smaller companies with a better earnings yield. The index is rebalanced annually. The portfolio turnover rate in the most recent fiscal year was 22%.

EPS portfolio

EPS invests exclusively in U.S. companies and mostly in the large cap segment (about 79% of assets). Technology is the heaviest sector (23.2%), albeit not as heavy as in the S&P 500 (29.1%). Compared to the S&P 500 (SP500), EPS significantly overweights communication services and energy. It underweights mostly technology and consumer discretionary.

The top 10 holdings, listed in the next table with valuation ratios, represent 32% of asset value. The weights of the top four names are in a 5% to 6% range. Risks related to other individual companies are low.

Ratios: Portfolio123.

EPS fundamentals and performance

As expected for a fund with a tilt to value, EPS is cheaper than the S&P 500 index regarding the usual valuation ratios, as reported in the next table.

In my ETF reviews, risky stocks are companies with at least 2 red flags among: bad Piotroski score, negative ROA, unsustainable payout ratio, bad or dubious Altman Z-score, excluding financials and real estate where these metrics are less relevant. Based on my calculations, risky stocks weigh less than 6% of asset value for EPS, which is a good point.

According to my calculation of aggregate metrics reported in the next table, quality is superior to the benchmark. The return on assets looks especially good.

Since 03/1/2007, EPS has underperformed the S&P 500 as represented by SPDR® S&P 500 ETF Trust (SPY) by about 37% in total return. The difference in annualized return is 55 bps, which is not very significant. Maximum drawdown and volatility (measured as the standard deviation of monthly returns) are similar to the benchmark.

Data calculated with Portfolio123.

EPS vs. competitors

The next tables and charts compares EPS to five of the most popular large cap value ETFs:

• Vanguard Value Index Fund ( VTV )
• iShares MSCI USA Value Factor ETF ( VLUE )
• First Trust Large Cap Value AlphaDEX® Fund ETF ( FTA )
• iShares Morningstar Value ETF ( ILCV )
• Invesco Large Cap Value ETF ( PWV ).

Data: Seeking Alpha.

EPS is the smallest (in assets) and the less liquid (in dollar volume) of these funds, shortly behind PWV. It has the lowest dividend yield of this group, but the expense ratio is on the cheap side.

It is the most expensive regarding valuation metrics, as reported in the next table.

However, EPS beats the competition in both 10-year and year-to-date total returns:

The predominance of market capitalization over earnings yield in the underlying index explains why EPS has beaten funds where valuation ratios are of greatest importance. EPS behavior is much closer to the S&P 500.

Takeaway

WisdomTree U.S. LargeCap Fund invests in about 500 large cap stocks weighted based on earnings. The methodology is intermediate between capital-weighting and value style based on earnings yield. It is less concentrated than the S&P 500 in the technology sector and shows more attractive valuation and quality metrics. However, performance since 2007 is not much different from the benchmark. In the last 10 years, EPS has outperformed large cap value funds due the predominance of mega cap companies in the portfolio. Capital-weighting and value are antagonist investing styles. By combining them, EPS takes the risk of gaining a limited interest from investors, because it looks like a watered-down value fund.

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