HDV - HDV Could Be A Solid Dividend-Focused ETF For 2024

2024-01-08 14:30:19 ET

Summary

• iShares Core High Dividend ETF is expected to generate solid returns in 2024.
• Improving fundamentals in healthcare, energy, and consumer defensive sectors support HDV's share price and dividend returns.
• Low valuations and a solid financial outlook for portfolio holdings contribute to potential shareholder returns.

After underperforming significantly compared to the S&P 500, the iShares Core High Dividend ETF ( HDV ) now appears to be well-positioned to generate solid returns for shareholders in 2024. The improving fundamentals of healthcare, energy, and consumer defensive companies are likely to support HDV’s share price and dividend returns in my view. Moreover, I believe low valuations and a solid financial outlook for its portfolio holdings are likely to contribute to shareholder returns.

A Shift from Hold to Buy Rating

Last year, when HDV’s share price was underperforming significantly and yields on treasuries exceeded the ETF’s dividend yield, I suggested investors avoid it and instead chase a dividend-focused ETF with the potential to offer both healthy dividends and steady share price growth. Dividends alone can’t help outperform the broader stock market index in a bull market. However, I now changed my rating to a ‘Buy’ for HDV. The primary reason for the change is a significant improvement in fundamentals for its key holdings. HDV’s share price rebound of nearly 12% in the last two months indicates a potential uptrend in 2024. In addition, three other factors - cheap valuations, rate cuts, and a limited upside for the broader stock market index- may also shift investors to low-beta dividend-focused ETFs.

After pushing interest rates to a 22-year high, the Fed is likely to cut rates three times in 2024. A rate cut is crucial for resuming investor confidence in dividend-focused ETFs. When rates rise, investors prefer to invest in short-term government securities that offer higher returns. A shift to fixed-income securities peaked last year. According to Bloomberg data , the yield premium on fixed-income securities has hit a 15-year high of 180 basis points compared to dividend returns. As rate cuts would lower yields on fixed-income securities, it would help shift investor confidence in high-yielding stocks and ETFs. Furthermore, significantly overvalued tech sector valuations could create a potential price correction or a limited upside for these stocks.

How Can HDV Generate Solid Returns?

HDV’s returns depend mainly on how healthcare and energy companies perform. The poor earnings quality of both sectors negatively impacted their returns in 2023. However, the double-digit earnings outlook for the majority of its key players in the healthcare, consumer defensive, and energy sectors strengthens the prospects for share price upside and dividend growth. For instance, Wall Street expects 9% year-over-year earnings growth for Johnson & Johnson ( JNJ ) in 2024. Similarly, AbbVie ( ABBV ) raised its 2024 adjusted diluted EPS guidance from $10.70 to $11. The company offers a lofty dividend yield of around 3.8%. Moreover, Merck’s ( MRK ) shares rallied nearly 12% in the last month alone in hopes of a strong outlook. The company raised its 2023 outlook after generating 7% revenue and 45% earnings growth in the third quarter. Wall Street expects healthy revenue and earnings growth for Merck in 2024.

On the other hand, the energy sector, which is expected to generate negative 29% earnings growth in 2023, is likely to bounce back with low mid-single to double-digit revenue and earnings growth. However, the emerging issues in the Middle East could trigger an upside in the crude oil price in the months ahead. Goldman Sachs anticipates oil prices to hover between $70 to $90 a barrel in 2024. A Reuters poll also shows a forecast in the range of $80. Oil prices in the range of $70 to $90 per barrel are high enough for US and global oil producers to earn healthy profits, given their significantly lower breakeven levels than forecasted prices. According to Statista data, US producers’ breakeven price on existing wells ranges from around $30 to $40 per barrel, while on new wells the price creeps up to $60.

Large-cap companies from the consumer defensive sector represent 17% of HDV’s portfolio. These companies have the potential to offer a steady share price and dividend growth over the long term. HDV’s top consumer defensive holdings include Philip Morris ( PM ), Coca-Cola ( KO ) and PepsiCo ( PEP ). Philip Morris generated record revenue of $9.4 billion in the September quarter of 2023, up 16% year over year. Its adjusted currency-neutral EPS of $1.67 increased by 20.3% year over year. The company anticipates 10% full-year earnings for 2023. Wall Street expects Philip Morris to sustain its growth momentum in 2024, which is a positive sign for high-yielding stocks. Wall Street also anticipates high single to double-digit earnings growth for PepsiCo and Coca-Cola in 2024.

Portfolio Characteristics and Valuations

HDV’s characteristics, such as a well-diversified portfolio with a strong concentration on 75 high-yielding large caps, make it a better play compared to its peers. Its low financial sector exposure also makes it a solid ETF to hold in 2024. The financial sector has seen high volatility in the past two years. There is a high risk of credit deterioration in 2024. Moreover, rate cuts would also negatively impact their earnings potential. On the other hand, the financial sector makes up a significant portfolio percentage of Fidelity® High Dividend ETF ( FDVV ) and First Trust Morningstar Dividend Leaders Index Fund ETF ( FDL ).

Moreover, HDV’s assets under management of $10 billion are the highest among peers. It also has the highest liquidity and the lowest expense ratio. HDV’s expense ratio of 0.08% is also significantly lower compared to the 0.15% and 0.45% of FDVV and FDL.

Valuation is also an important factor to consider. The ETF appears to be significantly undervalued, trading around 14 times earnings compared to the S&P 500’s 19 times. Moreover, the improving financial outlook of its portfolio holdings adds to its forward valuations. For instance, JNJ’s stock is currently trading around 15 times forward earnings and AbbVie’s around 14 times. Stocks from the consumer defensive sector, such as Philip Morris, Coca-Cola, and Pepsi, are also trading around 14 times earnings with robust financial outlooks. Exxon ( XOM ) and Chevron ( CVX ) also trade significantly below the S&P 500’s average.

In Conclusion

iShares Core High Dividend ETF is a solid option for both bull and bear scenarios in 2024 because of the robust fundamentals of its key portfolio holdings. The ETF also offers an attractive buying opportunity, given its low valuations and solid financial outlook for stock holdings. Furthermore, the low expense ratio and higher liquidity also make it a better play than its peers in my opinion.

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