SDY - SDY: Is State Street's Dividend ETF A Strong Income Vehicle?

2023-11-16 07:59:58 ET

Summary

• State Street S&P Dividend ETF is a dividend income-focused fund that tracks the S&P High Yield Dividend Aristocrats Index.
• The fund's top holdings include 3M Corp, IBM, Kimberly-Clark, Con Ed, and AbbVie.
• The SDY ETF has a 0.35% expense fee and a current yield of 2.7%.
• Today, I will review the SDF ETF to see if it might make sense for the "Dividend Income" category of your portfolio.

My followers know that I allocate portfolio capital in a top-down fashion and into various categories within the portfolio - with each category having a primary investment thesis (i.e. growth, tech, energy, income, etc). One of the most important categories in my portfolio is "Dividend Income". For retirees and investors of all age groups, investment income from dividend paying corporations can be a very enjoyable source of cash-flow because those companies work for you day-n-nite while you go on enjoying your life, and even when you are sleeping. Wise selection of dividend income paying companies also can deliver strong capital gains as well, resulting in excellent total returns . Today, I am going to take a look at the State Street S&P Dividend ETF ( SDY ) to see if it might deliver strong income and total returns and possibly make sense to hold in your portfolio.

Investment Thesis

According to State Street's SDY ETF homepage , where you can learn more details about the fund, the investment strategy is as follows:

• Provide investment results that generally track the total return performance of the S&P High Yield Dividend Aristocrats Index within the S&P Composite 1500 Index.
• That Index screens for companies that have consistently increased their dividend for at least 20 consecutive years. Then, the ETF weight-adjusts those stocks - on a quarterly basis - according to yield.
• The components within the Index itself are reviewed annually (in January) to determine if each issue should continue to be held in the Index.

The fund has an expense fee of 0.35% and State Street currently reports its yield as 2.7%.

With that as background, let's take a closer look at the fund and determine if it is a buy, sell, or a long-term hold.

Top-10 Holdings

The top-10 holdings in the SDY ETF are shown below and equate to what I consider to be a very well diversified 20.7% of the entire 121 company portfolio:

However, diversity is not always a good thing so let's keep digging.

Diversified conglomerate 3M Corp ( MMM ) is the top-holding with a 3.1% weight. 3M is an international provider of technology services and products through its four operating segments: Safety & Industrial; Transportation & Electronics; Health Care; and Consumer. The stock has been an extreme laggard over the past year (-25%), which is obviously not a good sign considering it's #1 status. 3M currently yields 6.3%. That being the case, 3M has all the classic signs of being a value trap.

The #3 holding is IBM ( IBM ) with a 2.3% allocation. The "old school" technology warhorse has shown some surprising resilience over the past couple of years. I say that because the bleeding of top-line revenue declines look to have been stabilized and turned around:

IBM currently pays a $6.64/share dividend and yields 4.41%. The last dividend increase was announced in April and was only $0.01/share .

Consumer products company Kimberly-Clark ( KMB ) has a 1.8% weight and is the #6 holding in the SDY ETF. Kimberly-Clark is up only 10% over the past 5 years. Over that same time frame, the quarterly dividend has risen from $1.00 to $1.18/share (18%). The stock currently yields 3.9%.

Utility company Con Ed ( ED ) is the #7 holding with a 1.8% allocation. ED stock is +18.5% over the past 5-years and its quarterly dividend has gone from $0.74 to the current $0.81/share (9.50%). ED stock currently yields 3.58%.

Drug maker AbbVie ( ABBV ) rounds out the top-10 holding with a 1.7% weight. As can be seen in the chart below, ABBV has delivered strong total returns in comparison to the other stocks I just mentioned. Unfortunately, only 1.7% of the SDY fund is in ABBVIE while the #1 holding (i.e. MMM) has been a total disaster for shareholders:

Performance

The average annual total returns of the SDY ETF are shown below:

As you can see, the YTD, 5-year, and 10-year average total returns are quite poor. That is especially the case as compared to the Vanguard 500 ETF ( VOO ), which has returned 10.6%, 10.98%, and 11.12%, respectively, over those same time frames. VOO, which is obviously not a dividend centric ETF like SDY, but it has an expense fee of only 0.03% and currently yields 1.60% (as compared to 2.7% for SDY). However, when you subtract the SDY ETF's high expense fee (i.e. 32 basis points) from its yield, the gap in yield between the two ETFs closes significantly. Meantime, you are rewarded with significantly higher capital appreciation (i.e. higher total returns).

The chart below compares the SDY's 5-year total returns against some other leading dividend centric ETFs: the Vanguard Dividend Appreciate ETF ( VIG ), the Schwab U.S. Dividend ETF ( SCHD ), iShares Core Dividend ETF ( DIVB ). I also added the VOO and ( QQQ ) ETFs to put some perspective on these dividend focused funds as compared to the broad market indexes:

As you can see, and not surprisingly, from a total returns perspective the Nasdaq-100 and S&P500 index funds have run rings around all these dividend focused funds. At this point, investors who have yet to read one of my most popular (and controversial ...) Seeking Alpha articles: Retirees Beware: Dividend Investing Is Overrated, should consider doing so.

The other observation is that, clearly, the SDY ETF is a very significant laggard as compared to all the other equities in the chosen group.

Risks

Looking at the valuation metrics below (taken from the SDY ETF homepage referenced earlier), the SDY ETF may appear like a great "value":

• Price-to-Book: 2.78x
• P/E = 16.50x

That is especially the case considering the price-to-book and P/E ratio of the S&P500 are significantly higher: 4.25x and 24.6x, respectively.

However, in general, and in my opinion, the portfolio of the SDY ETF is holds a lot of value traps that are not dynamic companies and that are no longer even raising their dividends at impressive rates. After all, what investor cares if a company has raised its dividend for 20 straight years if the last increase was only a penny a share?

Summary & Conclusions

The SDY ETF has a relatively stiff expense fee that does not appear to be worth it: the fund's long-term average total returns, dividend growth, and dividend yield are sub-par in my opinion. I advise investors to SELL this fund and either cobble together a group of ~5 individual stocks that exhibit excellent dividend growth and solid opportunities for capital appreciation - for example, like energy companies ConocoPhillips (COP) and Chevron ( CVX ), which have TTM yields of 4.0% and 4.16%, respectively - or invest in some of the much better performing dividend focused ETFs - VIG for instance. Yes, VIG is oriented toward dividend growth while SDY is not, but if you are going to invest for dividends, why not invest for dividend growth?

To put the recommendation above into perspective, I'll end with a 5-year total returns comparison of SDY with the VIG ETF, COP, CVX, and the S&P500 as represented by the VOO ETF:

As you can see, ConocoPhillips leads the group by a wide margin. COP has implemented the ( base+variable ) dividend policy and declares two payments each quarter.

Note also that the plain-old S&P500 has trounced all the dividend focused funds. As mentioned earlier, retirees beware ... or, at least understand what you are giving up by focusing on dividends and ask yourself the question: do I really need to focus so much on dividend income and is it worth it? For most investors - including retirees - I suspect the answer is "no". Regardless, I wish you success with your income oriented investments!

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