RNDV - RNDV Would Be A Buy If Not For A Few Weaknesses

Summary

• RNDV offers exposure to a basket of large-size dividend-paying U.S. equities with a sector allocation mostly similar to IVV and a tilt toward value.
• Since RNDV's underlying index incorporates a higher-yield factor, I was not surprised by its appealing valuation profile, i.e., the weighted-average last twelve months' earnings yield of ~6.3%.
• There is a plethora of high-quality undervalued stocks in the portfolio which should support its performance this year in case the abating inflation narrative-driven rally stops abruptly.
• However, I would stop short of the Buy rating due to a few concerns, including past performance, low yield, as well as liquidity.

The US Equity Dividend Select ETF ( RNDV ) offers exposure to a basket of large-size dividend-paying U.S. equities with a sector allocation mostly similar to the iShares Core S&P 500 ETF ( IVV ) and a tilt towards value. According to its website , "First Trust Advisors L.P. is the adviser to the fund."

Despite ending 2022 with a loss, RNDV still performed comparatively solidly amid the bear market turbulence, declining by just 7.6% while IVV was down by 18.2%. Also, there is a plethora of high-quality undervalued stocks in the portfolio which should support its performance this year in case the abating inflation narrative-driven rally stops abruptly.

However, RNDV does have a few significant disadvantages, so a Buy rating would be unjustified.

The basics of RNDV's strategy

RNDV tracks the Nasdaq Riskalyze US Large Cap Select Dividend Index which is rebalanced and reconstituted quarterly.

With the Nasdaq US 500 Large Cap Index being the selection universe, the index provider initially removes stocks that have not paid a dividend in the last twelve months as well as those with an LTM yield below the one of the large-cap index. Next, in the remaining group, weights are allocated to sectors strictly in line with the selection universe, which, on a side note, should make the RNDV portfolio a technology- and healthcare-heavy one for the foreseeable future. Finally, a stock’s weight within its respective sector is calculated on a yield basis, with high yielders (hence, better-valued names) climbing to the top spots.

Delving deeper into the portfolio

As of January 31, the fund had 219 holdings notwithstanding cash. With about 33% allocated to mega caps and no medium-size names in the mix, at all, the weighted-average market cap of the portfolio is about $80.8 billion, as per my calculations. A hasty conclusion could be drawn here that this result is principally influenced by technology players, yet in reality, the $1 trillion league is absent completely, and that was the healthcare that contributed most, with healthcare mega caps like Johnson & Johnson ( JNJ ) accounting for around 11.6% of the net assets. However, tech still made a profound impact also, with five IT companies valued at more than $100 billion accounting for over 9%. Regardless, as I will illustrate shortly, this did not lead to the lofty valuation.

Regarding sector exposure, little can be said since it essentially mimics the one of IVV owing to the index methodology, with minor deviations like comparatively smaller allocation to communication as illustrated by the chart below.

The yield-mindful strategy is supportive of comfortable valuation

Since RNDV's underlying index incorporates a higher yield factor, I was not surprised by its appealing valuation profile, i.e., the weighted-average last twelve months' earnings yield of ~6.3%, a level the IVV investors could only dream about. Of course, cheaper valuation frequently comes with soft growth, which is also the case with RNDV which is reflected in its 7.3% weighted-average forward EPS growth rate and also fairly bleak 6.3% forecast forward revenue growth, as per my calculations.

It is of note that the 3.3% WA dividend yield of this portfolio is almost 2x lower than the EY, a fact supportive of a hypothesis that the dividend quality of most holdings is robust as dividends are more than sufficiently covered at least by accounting earnings.

Moreover, non-financial and real estate companies in the basket have a median EV/EBITDA of 13.3x, which is fairly comfortable, I suppose.

Also, it is nice to see that 37% of the holdings have earned a Quant Valuation grade of B- and higher, a surprisingly strong result for a large-cap portfolio, even though close to 33% look overvalued compared to their respective sectors with the D+ grades and lower.

Size and dividend factors bolster quality

A solid indication of the robust quality of the RNDV portfolio is that almost 93% of the holdings have a Quant Profitability grade of B- and better, a respectable level. Meanwhile, those with poor margins or incapable to deliver on capital efficiency (D+ rated or worse) have only 3% weight, with most in this small group being either utility or real estate companies.

A minor disappointment is that loss-making firms could be spotted, though they have only a marginal impact on the fund's performance since they account for less than 5% of its net assets. Next, it is worth mentioning that cash-burning companies are almost completely absent notwithstanding three players, namely Bunge ( BG ), Stanley Black & Decker ( SWK ), and Paramount Global ( PARA ), combined accounting for 3%.

In sum, since RNDV's strategy is centered on the large-cap echelon, even without a sophisticated profitability screen incorporated, its portfolio should maintain decent quality characteristics over time as larger companies tend to have sector-leading margins and returns on capital as I illustrated a few times in my articles in the past.

The table below provides an overview of the top 10 holdings with key valuation, growth, and quality metrics combined for better context. As can be seen, most are attractively valued, with only D-rated Medtronic ( MDT ) being an exception.

Performance analysis

Though RNDV delivered a seemingly strong performance last year supported by its exposure to the value and quality factors, longer-term returns look less compelling.

Created by the author using data from Portfolio Visualizer

In particular, it underperformed the Schwab US Dividend Equity ETF ( SCHD ) as well as IVV during the June 2017 - January 2023 period (incepted in May 2017) as illustrated by the table above, also delivering a much higher standard deviation and soft risk-adjusted returns; the SPDR Portfolio S&P 500 High Dividend ETF ( SPYD ) did worse anyway, though mostly owing to its large value exposure that was a drag in the late 2010s but allowed it to outperform all the selected funds last year.

Final thoughts

In sum, RNDV has an appealing sector-neutral dividend strategy with a value ingredient and naturally robust quality principally owing to the large-size factor. It offers considerable earnings yield, though at the expense of tepid sales and EPS growth; regarding quality, RNDV is close to being the best in its echelon.

Last year, it showed resilience amid market turbulence, outperforming the ailing S&P 500 by a massive 10.6%. Nevertheless, other cheaper dividend ETFs still fared better, with much smaller losses delivered.

Considering RNDV might make sense for investors who would like to have exposure to above-average dividend yields available in the upper echelon of the U.S. market and also immunize their portfolios slightly from the prospect of inflation surprises and slower return to lower interest rates in the near future. However, I would stop short of the Buy rating due to a few concerns. First, an expense ratio of 50 bps is rather burdensome. Second, assets under management are fairly small at $25.5 million, and average daily share volumes are obviously lackluster. Third, its performance is not that appealing, lagging other cheaper, larger, more liquid dividend ETFs. Fourth, its dividend yield of only 2.4% is clearly low. And fifth, its dividend growth is bleak, with a 3-year compound annual growth rate at just slightly above 1%.

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