2023-11-29 00:00:58 ET
Summary
- Value is currently out of favor, both in the U.S. and internationally.
- Specific to the Vanguard High Dividend Yield ETF and the iShares International Select Dividend ETF, both are trading at discounted valuations.
- Especially in the case of IDV, it’s currently trading at single-digit P/E and yielding almost 7%, attractive both compared to the overall market and its own historical averages.
- Yet, you will see a few reasons why we prefer VYM despite IDV’s larger discount: better growth prospects, better total return potential, lower risks, and lower fees.
Thesis
Readers familiar with our writing know that our view is that value is currently out of favor, and we expect good odds of rotation towards value in the years to come. Against this overall viewpoint, this article will analyze two value funds, one domestic and one global, to both elaborate on our view and also offer some specific actionable ideas. The domestic fund we picked is the Vanguard High Dividend Yield ETF ( VYM ), and the global fund is the iShares International Select Dividend ETF ( IDV ). Both are well-known funds among dividend-seeking investors and high-dividend ETFs relative to many other equity investment options. As their names suggest, VYM offers exposure to large-cap US stocks with high dividend yields, and IDV offers exposure to international stocks with high dividend yields.
Moreover, both funds are currently trading at attractive valuation multiples, both in absolute and relative terms. As seen from the chart below, VYM is trading at 14.4x P/E, compared to the overall market's ~25x P/E. IDV's valuation is even lower, currently trading around a single-digit P/E of 6.6x. Later, we will see that their valuation is also attractive compared to their own historical averages. Both funds also feature robust profitability, with VYM's ROE (return on equity) hovering around 16.6% and IDV's around 12.6%.
Despite the lower P/E multiples from IDV (and also a slightly larger discount from historical averages as to be seen later), the remainder of this article will explain why we prefer VYM. Our key considerations are better growth prospects and better total return potential in the next few years.
VYM and IDV: Basic information
Let's start with a brief introduction to both funds in case they are new to some readers. As shown in the chart below, VYM follows the FTSE High Dividend Yield Index. It holds 453 domestic stocks. In contrast, IDV follows the DOW Jones EPAC Select Dividend index. It holds 100 ex-U.S. stocks. More details are their indexing methods are quoted below from their fund descriptions (with the emphasis added by me).
VYM summary : VYM seeks to track the performance of the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields. It provides a convenient way to track the performance of stocks that are forecasted to have above-average dividend yields. It follows a passively managed, full-replication approach.
IDV summary: IDV seeks to track the investment results of an index composed of relatively high dividend-paying equities in non-U.S. developed markets. It provides exposure to established, high-quality international companies. And it provides access to developed market stocks that have provided consistently high dividend yields over time. It can be used to expand income strategies to international markets.
VYM is a much larger fund, with a total AUM of more than $48B, compared to IDV's total AUM of ~$4.3B. Similar to many other Vanguard funds, VYM charges a rock-bottom low fee of 0.06%, while IDV charges a much higher fee of 0.51%. We will put the fees into perspective when we discuss their return potential later.
A closer look at valuation
As aforementioned, both funds are trading at attractive valuation multiples compared to the overall market. The next chart below shows that they are also trading at attractive valuations compared to their own historical averages. The chart evaluates their valuation in terms of their dividend yield, which is a better valuation metric (than say P/E) in my mind for funds that pay stable dividends.
To wit, VYM currently offers a TTM dividend yield of 3.17%. Compared to its 4-Year Average Yield of 3.12%, the fund is trading at a discount (albeit a small discount) of around 2%. IDV currently offers a TTM dividend yield of 6.8%. Compared to its 4-Year Average Yield of 6.38%, the fund is trading at a larger discount of around 7%. Overall, my conclusion is that their dividend yields provide another indication, in addition to P/E ratios, of their valuation discount.
Yet, next, we will explain why we still prefer VYM despite IDV's larger valuation discount.
Yet, we anticipate better returns from VYM
In a nutshell, we anticipate better growth prospects and hence better total return potential from VYM compared to IDV. In the long term, growth is governed by two fundamental forces: the return on capital employed ("ROCE") and the reinvestment rates. If you recall from the first chart, VYM has a better ROE (around 16.6%) than IDV (around 12.6%). Given the correlation between ROCE and ROE (see our blog articles for details), we have good reasons to believe that VYM also enjoys better ROCE than IDV. Therefore, assuming the same reinvestment rates (say 15%), VYM would offer a slightly faster (by about 0.5%) growth rate than IDV.
Furthermore, we also have good reasons to believe that VYM also features a higher reinvestment rate than IDV. First, it is true that both funds primarily hold stocks with high yields (e.g., consumer staples and financials) as you can see from the chart below. Yet, compared to IDV, VYM has more exposure to the technology sectors (with holdings like Broadcom) and pharmaceutical companies (with holdings like Merck and AbbVie). In contrast, IDV is more exposed to energy and basic materials, which tend to have fewer growth areas to deploy additional capital than technology and pharmaceutical companies. Second, their historical dividend growth rate also provides a hint about their investment rates. If you recall from the chart above, VYM has been growing its dividend at a CAGR of more than 5% in the past 5 years, while IDV has been growing at 2.42% in the same period. Assuming stable (and similar) ROCE, my explanation for such differences in their historical growth lies in the reinvestment rate.
All told, our return projections are shown in the next two charts for VYM and IDV, respectively. In these projections, we model a 5.0% growth rate for VYM. This consists of a real growth of around 2.5% (assuming a 15% reinvestment rate and 16.6% ROCE) and an inflation adjustment of around 2.5%. For IDV, we model a lower growth rate of 3.0% for the reasons discussed above. Based on these assumptions, you can see that VYM offers a more favorable return profile overall.
Other risks and final thoughts
To be perfectly clear, we are not trying to argue that IDV is a bad choice. It offers several key positives and is a solid choice under current conditions. Its valuation discount is quite large both by horizontal and vertical comparison. For investors who are primarily exposed to the U.S. domestic market, it provides global diversification. Furthermore, for investors who need current income, it also provides a much higher dividend yield than VYM.
Although in terms of total return in the next 3~5 years, we see a better return profile from VYM due to its better profitability and better growth prospects. IDV's total return has lagged VYM substantially in the past as you can see from the chart below, and we anticipate such lag to continue due to the fundamental return drivers. In addition, investors need to be aware of IDV's volatility risks too. As seen in the chart below, IDV historically has suffered far worse volatilities than VYM in terms of standard deviation, worst drawdown, and worst-year performance. Finally, as mentioned earlier, IDV also charges a higher fee of 0.51%. It is a reasonable fee in absolute terms. However, compared to our based case annual return of 4.7% in the next 3~5 years, the fee represents more than 10% of the total return potential. The picture is even worse when compared to its historical return. As seen in the chart below, the fund has returned 1.61% per annum since 2008. A fee of around 0.5% represents more than 30% of such a historical total return.
To conclude, we are in general bullish on value stocks and value sectors under current market conditions. To better illustrate our position and discuss actionable ideas, this article examines two value funds closely, one domestic ((VYM)) and one international ((IDV)). Both funds indeed look attractive with their robust profitability and valuation discount. However, in the end, we prefer VYM over IDV for a few key considerations: better growth prospects, better total return potential, lower risks, and lower fees.
For further details see:
VYM Vs. IDV: Why We Prefer U.S. Over International