2023-10-14 03:38:28 ET
Summary
- DON, with its smart-beta dividend-centered strategy, has an alluring high-single digit earnings yield, something investors on the lookout for sound value stories would definitely appreciate.
- On the negative side, other indicators are not that great, as only a third of holdings have a B- Valuation grade. I would prefer a larger allocation.
- Also, we see fairly subdued growth characteristics. Performance is only average, and sometimes even below average.
- Certain investors might find its dividend yield of 2.89% attractive, but I am not impressed.
- Even though DON has a few advantages, including monthly distributions, I would opt for a more conservative Hold rating.
It has been more than three years since I covered the WisdomTree U.S. MidCap Dividend Fund ETF ( DON ), so an update has certainly been long overdue. Today's article is supposed to provide mostly what I sometimes call a factor story, or a comprehensive view on how essential factors including value, growth, and quality are represented in its portfolio, highlight existing vulnerabilities, and identify advantages to decide whether a bullish case can be constructed. Dividend fundamentals, together with past performance, are also certainly to be reviewed. So let us dig in.
Recapping Strategy Basics: Smart Beta Prioritizing Rich Dividends
Since its inception in June 2006, the ETF has been leveraging a smart-beta dividend-centered strategy, tracking the WisdomTree U.S. MidCap Dividend Index, which was named the WisdomTree MidCap Dividend Index prior to June 30, 2017, as mentioned on its website . The following description is also provided:
The WisdomTree U.S. MidCap Dividend Index is a fundamentally weighted index that measures the performance of the mid-capitalization segment of the US dividend-paying market. The Index is comprised of the companies that compose the top 75% of the market capitalization of the WisdomTree U.S. Dividend Index after the 300 largest companies have been removed. The index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share.
DON Has Solid Value Exposure, But Pay Attention To Nuances
DON has respectable breadth and depth of exposure, with 343 holdings as of October 12, as the list available on its website shows. However, a nuance here is that, surprisingly, the WisdomTree U.S. LargeCap Dividend Fund ETF ( DLN ) was also in its portfolio, with a weight of 15 bps. So with DLN removed, we see 342 stocks and REITs. I would not say the fund has a top-heaviness issue, as the major 10 holdings account for just 10%.
Owing to the smart beta dividend-centered strategy, the sector mix that DON delivered is somewhat different from what mid-cap investors might have become accustomed to. In fact, as I have illustrated in the note on the Schwab U.S. Mid-Cap ETF ( SCHM ) published just recently, mid-cap blend vehicles typically have meaningful exposure to IT, i.e., SCHM had about 13% deployed to that sector, while DON has only a single-digit allocation. The top duo, consisting of financials and industrials, is rather similar to SCHM nonetheless. In the table below, I have also added a median earnings yield for each sector, and this is of course not a coincidence, as it will help us to explain a story behind DON's comparatively attractive valuation.
Created using data from DON and the iShares Core S&P Total U.S. Stock Market ETF (ITOT)
Below, I have compiled the factor parameters I consider most important.
Metric | 12-Oct |
Market Cap | $8.99 billion |
EY | 8.3% |
P/S | 2.52 |
EPS Fwd | 5.63% |
Revenue Fwd | 6.69% |
DY | 3.1% |
3Y Div CAGR | 10.78% |
5Y Div CAGR | 8.22% |
ROA | 7% |
ROE | 23.3% |
Quant Valuation B- or better | 34% |
Quant Profitability B- or better | 79% |
Created using data from Seeking Alpha and the fund
Overall, we see a solid factor story.
- The mix is dominated by mid caps, so investors are getting exactly what they should expect from a vehicle focused on medium-size companies. We see substantial exposure to large caps beneath the surface nonetheless, with 77 names sporting market values in excess of $10 billion, and the most expensive being $38.8 billion Interactive Brokers Group ( IBKR ), but portfolio-wise, the smart-beta strategy did an excellent job mitigating their impact on the weighted-average figure.
- There is a lot to appreciate when it comes to valuation. The earnings yield of 8.3% is the first parameter to mention. For context, SCHM is offering approximately 4.4%. But please bear in mind that the major contributors are financials and energy, as the sector allocation table illustrates. Both naturally tend to trade at a discount to the market.
- The spread between its WA earnings and dividend yields is indicative of meaningful dividend durability; in other words, constituents retain most of their earnings instead of returning them to shareholders via dividends. This might also be an indirect indication of their overall financial soundness.
- Next, we see the Price/Sales ratio more than 2x lower compared to SCHM.
- More than a third has a B- Valuation grade or higher. Though rather adequate, I would prefer a larger share.
- Exposure to top-profitability names is generally fine for a dividend-focused vehicle. Most companies in the basket allocate capital efficiently, as their ROA and ROE demonstrate. They are certainly not ideal, but anyway, the metrics are materially better than in the case of simpler market-cap-weighted funds.
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However, this nicely valued mix has one significant downside: growth, as both revenue and EPS growth rates are only in the mid-single-digits. It is worth explaining here that both figures are impacted by a large share of holdings with declining revenues (over 20%) and EPS (over 37%).
- I perfectly remember that a few of my dear long-term readers are focused on dividend growth, so I should definitely address this issue too. In fact, DON has strong weighted-average dividend CAGRs, especially a 3-year one. For better context, below are the WA CAGRs and the DY for SCHM, which are significantly lower.
DY | 3Y Div CAGR | 5Y Div CAGR |
1.7% | 6.98% | 5.45% |
Calculated using data from Seeking Alpha and SCHM
However, I decided to delve a bit deeper and find out whether these rates were skewed due to abnormally high contributions. And in fact, there are a few notable contributors with nuanced dividend growth stories. The main example is Range Resources ( RRC ), a pure-play Appalachian Basin natural gas & NGLs producer. RRC suspended the dividend in 2020, but then reinstated it in 2022, with a sizable increase; the ~152% 3-year CAGR is the consequence.
But nevertheless, even with RRC's CAGR reduced to zero for modeling purposes, the fund's weighted-average figure would go down by only 34 bps.
Overall, assuming prevailing uncertainty regarding the interest rates as the pressure from higher oil prices, including the ripple effects of the war in Israel , is yet to percolate into the CPI, a fund with an 8.3% EY and overall strong profitability characteristics looks like an opportunity to consider. However, the issue here is that I would stop short of a Buy rating, with the reason being its performance.
First, compared to the dividend ETFs I cover, DON has only average results. It did deliver a 3-year total return above the median in this cohort (40.5% vs. the median of 26.8%), but it lagged meaningfully over the 5-year period (32.9% vs. 34.7%). YTD, it has been one of the weakest names in the group, with an almost 2% decline vs. the median decline of 1.7%. For context, 23 names in the cohort delivered gains, with the First Trust NASDAQ Technology Dividend Index Fund ETF ( TDIV ) being the leader with a 17.5% price return.
Next, though DON did beat the SPDR® S&P MIDCAP 400 ETF Trust ( MDY ) over the July 2006–September 2023 period by a few bps, it still trailed it when it came to risk-adjusted returns (Sharpe and Sortino ratios). Besides, both MDY and DON significantly lagged the iShares Core S&P 500 ETF ( IVV ).
Portfolio | IVV | DON | MDY |
Initial Balance | $10,000 | $10,000 | $10,000 |
Final Balance | $47,216 | $39,090 | $40,550 |
CAGR | 9.42% | 8.22% | 8.45% |
Stdev | 15.61% | 18.66% | 18.53% |
Best Year | 32.30% | 33.25% | 37.58% |
Worst Year | -37.02% | -32.27% | -36.44% |
Max. Drawdown | -50.78% | -56.18% | -49.73% |
Sharpe Ratio | 0.58 | 0.46 | 0.47 |
Sortino Ratio | 0.85 | 0.64 | 0.68 |
Market Correlation | 1 | 0.92 | 0.95 |
Created using data from Portfolio Visualizer
Finally, I think its expense ratio of 38 bps is adequate, but it is still a bit too high for long-term investors who are planning to hold the ETF mostly to accumulate dividends over years, if not decades.
Investor Takeaway
DON, with its smart-beta dividend-centered strategy, has an alluring high-single-digit earnings yield, something investors on the lookout for sound value stories would definitely appreciate. Importantly, its EY is mostly boosted by financials and energy, which skewed the figure a bit. On the negative side, other indicators are not that great as only a third of holdings have a B- Valuation grade. I would prefer a larger allocation. Also, we see fairly subdued growth characteristics. Performance is only average, and sometimes even below average. Certain investors might find its dividend yield of 2.89% attractive, but I am not impressed. In all, even though DON has a few advantages, including monthly distributions, I would opt for a more conservative Hold rating.
For further details see:
DON: Strong Earnings Yield, But Subdued Growth, Performance Nuances