FDVV - FDVV: Invest In Dividend Safety In A High-Interest Rate Environment

2023-03-22 06:00:18 ET

Summary

• Inflation and recession fears are making investors seek safe havens such as high-quality dividend-paying stocks.
• Fidelity High Dividend ETF gives exposure to numerous high-quality dividend-paying stocks.
• FDVV’s holdings have good dividend safety scores, which is crucial in the current high-interest rate environment.

Introduction

The rising inflation and recession fears are making investors nervous and fueling volatility in the stock market. The recent collapse of two US regional banks, followed by the takeover of Credit Suisse ( CS ), has only added fuel to the fire. Many investors are now looking for safe havens, including dividend stocks that can act as a hedge against inflation while providing regular income.

There are several high-quality dividend stocks out there but through an ETF, investors can gain exposure to many of such stocks easily, and potentially further diversify their risk. In this article, I will take a closer look at the Fidelity High Dividend ETF ( FDVV ), an ETF that gives exposure to high-quality dividend-paying stocks. We'll examine the ETF's top holdings and focus on dividend safety, which I believe is crucial in the current high-interest rate environment.

FDVV: The Benefits of Dividend Stocks

The current financial landscape is uncertain, with rising inflation and recession fears causing fluctuations in the stock market. The recent events in the financial sector, especially the collapse of Silicon Valley Bank ( SIVB ) and Signature Bank ( SBNY ) and the takeover of Credit Suisse ( CS ) by UBS ( UBS ), have added to concerns about the health of the global financial system. It's reminding many of the 2008 global financial crisis, even though the current situation is different. Unlike the previous time, we are now dealing with strong demand that is causing inflation. Nevertheless, the crisis in the banking sector is exacerbating existing worries about inflation and recession, making investors even more nervous. In these uncertain times, investors are seeking ways to protect their assets and generate income.

Dividend stocks can offer both of these benefits, acting as a hedge against inflation while providing regular dividend income. FDVV is an ETF that seeks to provide exposure to high-quality dividend-paying stocks. The ETF tracks the Fidelity High Dividend Index and has $1.4 billion in assets under management. While smaller in size compared to other dividend ETFs like the Vanguard High Dividend Yield ETF ( VYM ) that manages more than $60 billion of assets, FDVV stands out with a higher 30-Day SEC Yield of 5.9%, compared to VYM's 3% and the S&P-500 average of 1.71%.

Portfolio Overview

FDVV holds more than 80 stocks, with its top ten holdings consisting of some of the biggest names in the industry, including tech giants Apple ( AAPL ) and Microsoft ( MSFT ), which are the ETF's two largest holdings, investment bank JPMorgan Chase ( JPM ), oil major Exxon Mobil ( XOM ), and the world's largest consumer goods maker Procter & Gamble ( PG ).

A quick look at FDVV's top ten holdings reveals two important things. Firstly, the ETF allocates just a small portion of its funds to any one company, resulting in a highly diversified portfolio with minimal risks from significant exposure to a single stock. Its top stock, Apple, accounts for just 5.2% of the ETF. As a result, if one of its holdings experiences a decline or sell-off, it won't have a major impact on FDVV's performance.

Secondly, despite having "high dividend" in its name, the ETF is not solely focused on high yields. This is clear from its top two holdings, Apple and Microsoft, whose dividend yields are less than 1%. This is a positive aspect, as a focus solely on yield can sometimes be a losing strategy. Remember, high yields can be a precursor to a dividend cut, as seen with Intel ( INTC ) in February. FDVV seems to consider both yield and the safety of dividends, which is important for investors to keep in mind when making investment decisions.

Safety First

Dividend safety might become even more critical in the coming years. As interest rates rise, it's going to affect the earnings of numerous companies, especially those that have high levels of debt. You don't have to be a financial wizard to understand that when interest rates rise, it becomes more expensive for companies to borrow money. This puts a squeeze on their bottom-line and can even threaten their ability to pay dividends.

As we await the Federal Reserve's decision on whether to hike the benchmark policy rate on Wednesday to tackle inflation, it's clear that the current environment is challenging. The central bank's target range is currently 4.5% to 4.75%, and 72% of traders are expecting a 25 basis points increase, as per the CME Group . I think this is a reasonable estimate. Unless there are clear signs of a global catastrophe in the financial sector, the Fed will likely continue to focus on its target of curtailing inflation and preventing the economy from overheating.

Although inflation has cooled off a bit, the Personal Consumption Expenditures Price Index (the Fed's preferred inflation measure) rose by 5.4% in January compared to a year earlier, which is substantially higher than the central bank's 2% target. The Fed might remain focused on reining in inflation before it becomes an even bigger problem. Even if the central bank hits the pause button, I expect further hikes in the future.

The high-interest rate environment is going to be a real headache for many companies. As debt becomes more expensive, interest expenses will soar, eating away at their profits and cash flows. This is particularly concerning for companies that are already stretched thin. They may struggle to fund capital expenditures, make acquisitions, or even pay dividends. And let's not forget the ominous specter of a potential recession, which could add to their troubles.

So what should investors do? Well, now more than ever, it's crucial to prioritize dividend safety. Sure, it can be tempting to go after high dividend yields or companies with a long history of dividend growth. But these factors may give a false sense of security. Instead, savvy investors should focus on companies with a solid financial position and sustainable dividend payout ratios. These are the companies that are more likely to weather the storm and continue delivering returns to their shareholders, even in turbulent times.

In this context, I think the biggest strength of FDVV is that it gives investors exposure to those companies that are in sound financial health and will likely continue rewarding shareholders with dividends, even as the interest rates climb and the economy slows down. Around 70% of the ETF's holdings - representing a combined weight of 86% - have robust dividend safety scores ranging from B- to A+, as per data from Seeking Alpha. This is great news for investors who are looking for reliable dividend income.

Take Apple, for example. This tech giant has a solid dividend safety score of A-. Its dividend payout ratio of just 15.6% is lower than the industry median of 33%, and it has consistently generated strong levels of free cash flow. Although Apple comes with a dividend yield of just 0.6, other companies in the FDVV ETF, like Exxon Mobil, offer above-average dividend yields while still maintaining strong dividend safety scores.

While FDVV is a great ETF that provides exposure to high-quality dividend-paying stocks, it's important to note that it’s not filled entirely with solid stocks. There are some low-quality names in FDVV as well, such as McDonald's Corporation ( MCD ), NIKE ( NKE ), Lowe's Companies ( LOW ), and Starbucks ( SBUX ), that have weak dividend safety scores of D+ or lower due to higher payout ratios, weak levels of cash flows, or other factors. Starbucks, for instance, has a dividend payout ratio of 71%, more than twice as large as the industry’s average of 31%. These companies may struggle to maintain their dividends if the going gets tough, making them a potential risk to investors.

The good thing, however, is that these low-quality companies get very little exposure in FDVV. The ETF has allocated just around 13 % of its assets to companies that exhibit weak dividend safety scores of between C+ and D-, data from Seeking Alpha shows. As a result, they are unlikely to have any major impact on the ETF’s performance.

Takeaway

In short, I think FDVV is a great dividend ETF that seems to have dividend safety at its core. It gives investors exposure to dozens of high-quality names that are more likely to weather the storm and continue delivering returns to their shareholders, even as the Fed increases interest rates and recession fears mount.

While FDVV has a lot of benefits, it's worth noting that it isn't the cheapest ETF out there. In fact, a little over 70% of its holdings are trading at unattractive multiples of earnings, sales, and cash flows, with low valuation scores of between C and F. This includes all of its top 10 holdings, like Apple, which is currently trading at 26x forward earnings estimate, higher than the industry's median of 20x. Of course, one could argue that quality stocks usually trade at a premium over peers, and that's why the higher valuation can be justified. However, I think the price levels are a bit too high for my liking right now. Nevertheless, I believe FDVV is a great ETF to add to your watch list and consider buying on weakness. Its focus on dividend safety makes it an attractive investment option, particularly in these uncertain times.

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