VYMI - VYMI: International Blue Chip Exposure At A Fair Price

2023-09-20 14:52:17 ET

Summary

• VYMI has underperformed its close peer VYM since inception. US stocks in general have grown earnings faster than international peers, even if they have also enjoyed some multiple expansion.
• VYMI's stock selection methodology is sound. Weighting higher dividend yield stocks by market-cap results in more of a blue chip fund than the high yield fund its name suggests.
• VYMI's basket of stocks trades at a suitably low valuation. It has a good shot of narrowing its underperformance versus VYM.
• As such, now might be a good time for investors who would be open to some international blue chip exposure to consider this name.

US-based investors would be forgiven for not feeling the need to own equities beyond their own shores. Packed full of diverse, high quality stocks, the home market is known for being uniquely deep. Also, although listed in the US, that doesn't mean business is exclusively conducted there. Around four in every ten dollars of revenue generated by the S&P 500 is generated in markets other than the United States. Indeed, owning a US blue chip stock often also means owning their various foreign subsidiaries too.

There's another very good reason for a decisive home bias: US stocks have outperformed their international peers. Here's the total return of the subject of today's piece, the Vanguard International High Dividend Yield Index Fund ETF ( VYMI ), versus that of its larger US-focused cousin, the Vanguard High Dividend Yield Index Fund ETF ( VYM ), since the former's inception. The difference is stark:

Some of that outperformance may stem from the fact that US stocks have become more expensive in recent years relative to international stocks. Below is a chart from Yardeni Research showing the historical forward P/E ratio of the US and the MSCI ACWI ex-US.

While multiple expansion has been a tailwind for US stocks, it is still only part of the story. Earnings growth has also been stronger at home. Below is a chart from the fund manager at F&C Investment Trust plc ( OTCPK:FLIVF ), which is one of the largest closed-end funds in the United Kingdom. It illustrates very well the extent of EPS outperformance in US stocks versus stocks from the rest of the world.

A part of the gap is due to share buyback schemes being a more common form of capital return in the United States (as opposed to just paying out dividends, which is more common elsewhere). This would inflate US EPS growth, but still isn't enough to explain the full extent of the difference.

The Value Case For VYMI

Before outlining the value case for VYMI, let's start with a brief word on its stock selection methodology.

Although VYMI's full title includes the phrase "High Dividend Yield Index", this is slightly misleading, and I mean that in a good way. As with cousin VYM, although VYMI's target index does indeed rank by forecast dividend yield, excluding the lower half from its universe, constituents are then weighted by market capitalization.

What you end up with is something that looks more like a diversified blue chip fund of dividend paying stocks than simply a crude "high yield" one. Below is VYMI's top ten holdings as per Seeking Alpha , which illustrates this effect nicely. Stocks like Unilever ( UL ), Roche ( OTCQX:RHHBY )( OTCQX:RHHBF ), Novartis ( NVS ), Royal Bank of Canada ( RY ) and Sanofi ( SNY ) are typically in the sweet spot of offering a better-than-average dividend yield plus modest annual growth on top. This is also the case for VYM, so pairing them together would result in a very nice global blue chip portfolio.

Although VYMI has underperformed VYM by a cumulative 40.5ppt since the former's inception in 2016, past performance is not always a good guide to future returns, especially since the stock selection processes of these two funds are very similar.

The value case for VYMI actually looks pretty good right now. I mean, it trades on a blended P/E of just 9x according to Vanguard. That is a 40% discount to the 15x of VYM. Its price/book (1.2x as per the same source) is a 50% discount to the 2.5x commanded by VYM. Now, that is offset by VYM's higher profitability. Its basket of stocks earns a 15.8% blended ROE, which is around 45% higher than the 10.9% enjoyed by VYMI.

The math is largely a wash. According to Morningstar, the underlying dividend yield of VYMI's portfolio is around 6%. Taking our P/E data from above, that would seem to imply a payout ratio of around about 55%.

If VYMI's basket earned 10.9% on the retained (in line with its ROE above), you would get about 5% growth on top. That results in a maximum return of around 11% per annum. VYM also pays out around 55% of its earnings by way of dividends (a 3.5% underlying dividend yield on a P/E of 15). If it earned the full 15.8% ROE on the retained, growth would land at around 7.2%. You would again end up with around 11% long-term annual returns at the high end.

At worst, the above means that VYMI has a decent shot of halting its record of underperformance versus VYM in the years ahead, even if the latter grows earnings at a higher clip. As a result, in VYMI investors have a good opportunity to increase their equity diversity to incorporate international blue chip without leaving much on the table by way of lower returns.

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