Tag Archives: opinion

3 Dividend ETFs With Yields Over 3% And 1 Coming Respectably Close

Summary These four dividend ETFs have similar expense ratios but substantially different holdings. DVY looks like the ETF with the highest chance to go on sale in December if the Fed Funds rate is increased. DVY and DTN have zero exposure to real estate which may be favorable for investors concerned about income taxes on REITs. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered and explaining what I like and don’t like about each in the current environment. The Four ETFs Ticker Name Index QDF FlexShares Quality Dividend Index ETF Northern Trust Quality Dividend Index DHS WisdomTree Equity Income ETF WisdomTree High Dividend Index DTN WisdomTree Dividend ex-Financials ETF WisdomTree Dividend ex-Financials Index DVY iShares Select Dividend ETF Dow Jones U.S. Select Dividend Index By covering several of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. For investors that want to see precisely which assets I’m holding, I opened my portfolio near the end of November. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. The FlexShares Quality Dividend Index ETF is the weakest of the batch on dividend yields, but I wouldn’t consider 2.78% even remotely bad. That is a very respectable dividend yield for an equity portfolio that is not focused on carrying REITs, BDCs, or other very high yield investments. The two WisdomTree funds both come in with very high dividend yields. (click to enlarge) Expense Ratios These funds are all extremely similar on expense ratios. (click to enlarge) Sector Even if an investor was going to focus on dividend yields, there are three funds with yields that are materially above 3%. The expense ratios are also very similar which reinforces that investors need to be looking at the sector allocations to make the determination of which ETF makes the most sense for them. I built a fairly nice table for comparing the sector allocations across dividend ETFs to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) First Glance I imagine most readers looking at that glance first noticed the exceptionally tall purple bar representing the utility allocation for DVY. This is a dividend growth fund that has a fairly huge allocation to the utility sector. DVY DVY uses a very heavy allocation to utilities. For investors that already build their own utility positions in their portfolio, this wouldn’t be a great fit since it would double up on the exposure. On the other hand, for the investor that does not have utility exposure in their portfolio, the ETF could be a great fit. The utility sector often demonstrates some correlation with bonds because investors treat it as an alternative source of income. This may be a fairly volatile sector going into December because investors are expecting the Federal Reserve to raise rates and if a rate increase is confirmed it could send bond yields higher and utility stocks would be expected to fall at the same time so that the dividend yields would increase. I won’t be surprised if the Federal Reserve raises rates in December, but if they manage to raise rates 5 more times within the next year and a half I would be quite surprised. I don’t expect great results on the increase in rates, so I don’t think the following years will see further increases. I wouldn’t be surprised if see the Federal Reserve’s short term rate fall back to 0% before it makes it up to 1%. DTN and DVY In addition to being heavy on utilities, DVY joins DTN in having no allocation to real estate. I don’t mind the exclusion of real estate since I expect many investors may want to use this kind of dividend growth ETF in a taxable account while pushing their REIT exposure into a tax exempt account. For an investor putting a large part of their portfolio in either of these ETFs, it would be reasonable to look for some exposure to REITs somewhere else in the portfolio. I’m using equity ETFs for around 20% to 25% of my portfolio and I may look to increase that in December and going into next year if the REITs are on sale following an increase in the Fed Funds rate. DTN also has virtually no exposure to the financial services sector. Since their name includes “ex-Financials”, I think that makes a great deal of sense. DTN would fit best in a portfolio where the investor was manually choosing their own bank stocks and REITs for the portfolio. QDF QDF offers the lowest dividend yield and when I look at the sector allocations it appears fairly aggressive for a dividend portfolio. The allocation to utilities and consumer defensive are both fairly low and in both cases QDF has the lowest allocation in the portfolio. In my opinion, the best scenario for QDF relative to the other ETFs would be a longer bull market where more aggressive allocations would be rewarded. Compared to an actual aggressive allocation, this would be fairly tame but when compared to other high yield portfolios it is less defensive. What do You Think? Which dividend ETF makes the most sense for you? Do you use DVY to get your utility allocation, or do you pick your own utilities (or use a different ETF)? Is the dividend yield on DVY or DTN enough to bring you into the ETF? The only major weakness I see for this batch of ETFs is that the expense ratios are higher than I would like to see. However, when choosing between these four ETFs the ratios are very comparable.

HACK: Too Much Industry Hype, Too Little Fundamental Support

Summary Cyber-security market top line growth doesn’t necessarily translate to profit growth for companies. Most companies are still spending a large portion of gross profit on R&D for new software/hardware solutions and marketing & selling to boost brand recognition and gain market shares. Until the industry consolidates and SG&A costs stabilize, it’s hard for these companies to retain profits. Recommendation: Sell Although the cybersecurity market is expected to grow at a phenomenal rate, in my opinion it doesn’t necessarily translate to profit growth for companies. Since cybersecurity is a relatively new industry, most companies are still spending a large portion of gross profit on R&D for new software/hardware solutions and marketing & selling to boost brand recognition and gain market shares, resulting in negative bottom line for most companies. Choppy as the cash flow from operation (CFO) growth is, most cybersecurity companies have positive operating cash flow and incur little CapEx. Going forward, keeping up with hacker’s technology requires constant R&D spending on upgrading and updating technology, and large marketing & selling expense to compete for market shares remains a headwind for these companies in this highly fragmented market. Until the industry consolidates and SG&A costs stabilize, it’s hard for these companies to retain profits. ETF Info Price 27.16 52 Wk H 33.91 52 Wk L 18.29 30D Avg Volume 396,270 Market Cap 1,114,917,969 Shares Out 41.05 Return YTD 3.66% Excess Return YTD -1.97% Tracking Error 1.70 Inception Date 11/12/2014 Expense Ratio 0.75% ETF Summary The PureFunds ISE Cyber Security™ ETF (NYSEARCA: HACK ) tracks the price and yield performance of the ISE Cyber Security™ Index, which includes companies or ADRs that are hardware/software developers for cyber security (“Infrastructure Providers”) or non-development service providers (“Service Providers”). The ISE Cyber Security index assigns weights to companies according to category (“Infrastructure providers”/”service providers”) and then is adjusted according to liquidity and market cap. For more information, you can refer to the PureFunds website . Companies Updates When looking at financial statements of the holding companies, other than 6 companies that had negative sales growth for the past year (~-5%), 26 companies had 10%+ sales growth with on average 70% gross margin. A large chunk of gross profit goes to R&D and Selling & Marketing expenses, resulting in negative profit margin for some of the companies. The gap between sales growth and net income growth is largely attributable to SG&A spending. Most of these companies don’t incur much CAPEX and have positive free cash flow when adding back non-cash charges (mostly stock-based compensation and debt amortization). However, the stock-based compensation is a meaningful real expense and will likely to continue due to continuous talent acquisitions. Operating cash flow growths are choppy and unpredictable. These companies have a median forward PE of 22.7x and average forward PE of 40x (vs. S&P 500 average 18.7x forward PE). Among the top 10 holdings, 5 are experiencing fast sales growth for the past several years, 4 have stagnant growth, and 1 had negative growth (shown later in this article). MIN MAX MEDIAN AVERAGE S&P 500 Sales growth (%, FY) -23.2 163.5 8.2 16.1 Net Income growth (%, FY) -2620.1 1865.2 -11.4 -70.9 EBITDA growth (%, FY) -230.5 123.6 5.2 -14.5 CFO growth (%, FY) -122.4 302.8 3.7 21.3 FY Gross margin 9% 95% 76% 67% FY EBITDA margin (adj) -89% 62% 11% 8% FY Operating margin -111% 56% 9% 4% FY Net margin -112% 44% 5% -1% FY CFO/sales -31% 59% 19% 18% FY FCF/sales -47% 56% 14% 14% FY capex -3879.7 -1.4 -14.5 -244.8 FY FCF/capex -2.9 60.7 4.4 8.0 PE(forward) 13.7 312.1 22.7 40.4 18.7 PB 0.9 38.8 5.1 7.5 2.8 *data gathered from yahoo finance and Bloomberg, compiled by author Looking at the table above, the median sales growth is 8%, meaning more than 50% of these companies are doing fine on the top-line. However, median net profit growth is negative, meaning profits for more than 50% of the companies are shrinking. Would you buy into an industry where profits for companies are stagnant or shrinking? Probably not. What worsens the situation is the assigned weights. This ETF is almost as if it’s assigning equal weight to all the companies – the largest holding is 4% and the smallest is

CET: An Out Of Step Old Timer That’s On Sale

Central Securities Corp. is one of the oldest closed-end funds around. It sticks to a value focus, which has kept it out of sync with the broader market of late. But with an around 20% discount, it might be worth a look for patient investors. Central Securities Corp. (NYSEMKT: CET ) is one of those closed-end funds, or CEFs, that kind of gets lost in the crowd. It hasn’t been a standout performer lately and what it does is, well, kind of boring. But for a long-term investor seeking a value fund it might be just the kind of boring you’ll like since it’s trading at an around 20% discount. Value versus growth There are two broad camps in the investing world, value and growth. There’s a lot of wiggle room in there, but it can be interesting to compare the two broad-based approaches. For example, since the bottom of the market was reached during the deep 2007 to 2009 recession, the Vanguard Growth ETF (NYSEARCA: VUG ) had handily outdistanced the Vanguard Value ETF (NYSEARCA: VTV ). VUG data by YCharts That’s not so surprising in hindsight, but it provides an important backdrop for research. If you are looking at a growth-focused CEF and comparing it to the market, it will probably look good. If you are looking at a value-focused CEF, well, not so much. Which is where Central Securities comes in. CET is a value fund and, perhaps, worse, it likes to own securities for a long time-which means it isn’t likely to switch into today’s hot stocks to follow the lemmings or to window dress its portfolio. In other words, when Central Securities is out of step with the market, it can look like a lousy investment option. But long-term performance suggests it isn’t. For example, the CEF’s trailing annualized 25-year return through December 2014 was around 12% compared to 9.5% for the S&P 500 Index, according to the fund. It held a similar, though not quite as large, edge over the trailing 20-year period, too. Over shorter periods, however, it has generally lagged. For example, over the trailing 1-, 3-, 5-, 10-, and 15-year periods through October Central Securities lags the broader market. The shortfall narrows materially the further back you go. For example, over the trailing 15 years, Central Securities’ annualized net asset value total return, which includes reinvestment of distributions, was roughly 4%. Over that same span the S&P’s total return was 4.5% or so. Over the trailing year through October, however, Central Securities was down roughly 1% while the S&P was up about 5%. Percentage wise, that’s a huge rift. But the backdrop is critical. VUG and VTV offer up a similar disparity. So, in some ways, Central Securities is doing what you’d expect. Moreover, leading into 2000, roughly 15 years ago, the market has been dominated by cycles of boom and bust. We are currently in an up cycle, in my opinion, highlighted once again by tech darlings sporting extreme valuations. In other words, not much has changed since the turn of the century. And that’s left a closed-end fund like Central Securities out of step. The long, long term But the thing to keep in mind about Central Securities is that it’s been in business since 1929. So it doesn’t think in days, months, or years. It thinks in decades… or longer. For example, three of its top-10 positions were purchased in the 1980s and one was bought in the 1990s. Yet another was added in 2000. That doesn’t mean it won’t buy and sell stocks when it sees opportunities, but when it buys a company it often holds for a long time (the other half of the top 10 were purchased in 2007 or later). Such long holding periods are not the norm in the fund world. So, almost by design, Central Securities is out of step. According to the fund : Our approach is to own companies that we know and understand, which we believe reduces risk. We also consider the integrity of management to be of paramount importance. We try to find new investments available at a reasonable price in relation to probable and potential intrinsic value over a period of years into the future and then hold them through the inevitable market ups and downs. If you think that sounds like something you’d expect out of Warren Buffett’s mouth, you’d be right. So why now? The interesting thing about Central Securities right now is its nearly 20% discount to net asset value. That’s fairly wide for this fund, which has a 10-year average discount closer to 16%, according to the Closed-End Fund Association-a level at which it traded when I last looked at the fund earlier this year. If you look back over the fund’s history on a quarterly basis 20% is a relatively infrequent number to see. Which helps explain why the fund repurchased roughly 775,000 shares through the first nine months of the year. The average price on those purchases was around $21. Central Securities’ shares have recently been trading hands below $20. If you are looking for a value-focused fund with a long-term history of success, this might be a good option for you. Just be prepared to hold for a long time and to handle being out of step with the market for sometimes lengthy periods. But when value comes back into favor, which history suggests it will, this fund’s willingness to stick to its knitting should shine through. The caveats But that doesn’t mean it’s right for everyone. For starters, if you are an income investor, the fund only pays semi-annually. And the distribution has varied greatly over time. So you can’t really count on Central Securities for income. It does have a lot of unrealized capital gains in the portfolio, which isn’t surprising given its penchant for owning stocks for long periods of time. However, that doesn’t mean it will sell them just to fund a distribution, only that it could do so if it wanted. Another wrinkle here is that the CEF’s largest holding is The Plymouth Rock Company, a non-traded insurance company. That one position makes up nearly 20% of the portfolio. That means management is pricing a huge chunk of the portfolio by itself. It has a system in place for that, but Central Securities does not own a diversified portfolio. It’s worth noting that The Plymouth Rock Company has been actively buying back its shares. Central Securities, for example, sold 6,000 shares in the third quarter, leaving it with over 28,400 shares worth a total of $109 million at the end of the quarter. CET has a massive unrealized gain in this one investment, since the initial cost was only about $700,000. Which helps explain why Central Securities has pretty much told The Plymouth Rock Company that it is willing to sell, but only a little at a time and only if the price is right. So this issue is likely to get smaller as time goes on. (A shout out to Papaone for digging that nugget out of a Plymouth Rock report.) Whether or not a concentrated portfolio and difficult to gauge dividends are reasons to bypass Central Securities is really going to be based on your investment preferences. But I would say conservative income-focused investors would probably be best off looking elsewhere if you are trying to replace a paycheck. However, Central Securities is well worth a deep dive if you are looking for a value-focused fund that has proven it won’t change its stripes and see the income it throws off as a side benefit and not the main show.