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How To Avoid The Worst Style ETFs: Q1’16

Question: Why are there so many ETFs? Answer: ETF providers tend to make lots of money on each ETF so they create more products to sell. The large number of ETFs has little to do with serving your best interests. Below are three red flags you can use to avoid the worst ETFs: Inadequate Liquidity This issue is the easiest issue to avoid, and our advice is simple. Avoid all ETFs with less than $100 million in assets. Low levels of liquidity can lead to a discrepancy between the price of the ETF and the underlying value of the securities it holds. Plus, low asset levels tend to mean lower volume in the ETF and larger bid-ask spreads. High Fees ETFs should be cheap, but not all of them are. The first step here is to know what is cheap and expensive. To ensure you are paying at or below average fees, invest only in ETFs with total annual costs below 0.48%, which is the average total annual cost of the 298 U.S. equity Style ETFs we cover. The weighted average is slightly lower at 0.17%, which highlights how investors tend to put their money in ETFs with low fees . Figure 1 shows that the AdvisorShares Madrona Domestic ETF (NYSEARCA: FWDD ) is the most expensive style ETF and the Schwab U.S. Large Cap (NYSEARCA: SCHX ) is the least expensive. Absolute Shares Trust ( WBIB , WBID , WBIC , and WBIG ) provides four of the most expensive ETFs while Schwab ( SCHX and SCHB ) and Vanguard ( VOO and VTI ) ETFs are among the cheapest. Figure 1: 5 Least and Most Expensive Style ETFs Click to enlarge Sources: New Constructs, LLC and company filings Investors need not pay high fees for quality holdings. The State Street SPDR S&P 500 Buyback ETF (NYSEARCA: SPYB ) earns our Very Attractive rating and has low total annual costs of only 0.39%. On the other hand, a fund such as the iShares Core U.S. Growth ETF (NYSEARCA: IUSV ) holds poor stocks. No matter how cheap an ETF (0.08% TAC), if it holds bad stocks, its performance will be bad. The quality of an ETFs holdings matters more than its price. Poor Holdings Avoiding poor holdings is by far the hardest part of avoid bad ETFs, but it is also the most important because an ETFs performance is determined more by its holdings than its costs. Figure 2 shows the ETFs within each style with the worst holdings or portfolio management ratings . Figure 2: Style ETFs with the Worst Holdings Click to enlarge Sources: New Constructs, LLC and company filings PowerShares ( EQAL , PXMV , and EQWS ) appears more often than any other providers in Figure 2, which means that they offer the most ETFs with the worst holdings. The ProShares Ultra Telecommunications ETF (NYSEARCA: LTL ) is the worst rated ETF in Figure 2. The PowerShares Russell MidCap Pure Value ETF (NYSEARCA: PXMV ), the PowerShares Russell 2000 Equal Weight ETF ( EQWS ), the Vanguard Russell 2000 Growth Index Fund (NASDAQ: VTWG ), the Global X Super Dividend U.S. ETF (NYSEARCA: DIV ), and the Guggenheim S&P Small Cap 600 Pure Value ETF (NYSEARCA: RZV ) also earn a Dangerous predictive overall rating, which means not only do they hold poor stocks, they charge high total annual costs. Our overall ratings on ETFs are based primarily on our stock ratings of their holdings. The Danger Within Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. Put another way, research on ETF holdings is necessary due diligence because an ETF’s performance is only as good as its holdings’ performance. PERFORMANCE OF ETFs HOLDINGs = PERFORMANCE OF ETF Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Stock Spinoff Performance By Market Cap

I wanted to share a quick stock spinoff analysis. I downloaded all the stock spinoff data that was available on Bloomberg and then analyzed total 1-year returns, 3-year returns and 5-year returns by market capitalization. Here is what I found: micro-cap spinoffs outperform in year 1. Specifically, “Less than $500M Market Cap Spinoffs,” “Less than $100M Market Cap Spinoffs,” and “Less than $50M Market Cap Spinoffs” generated total 1-year returns of 29%, 37%, and 55%, respectively. However, over longer time periods, the outperformance of micro-cap performance fades. Over longer time periods, the best-performing spinoff market cap cohort is “Less than $1B” which generated 3-year and 5-year total returns of +69% and 170%, respectively. Here are the charts: Click to enlarge Click to enlarge Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Should You Buy A Company After A Dividend Cut?

By Rupert Hargreaves Should you buy a company after it has cut its dividend? That’s the question Morgan Stanley’s analysts have tried to answer in a European Equity Strategy research note sent to clients today and reviewed by ValueWalk. Morgan’s research has been prompted by renewed investor interest in dividend cuts. Against a depressed earnings base, the market’s dividend payout level looks high in a historical context and the median stock’s payout ratio is close to a 20-year high. On a pan-European level, the payout ratio has exceeded 2009 levels. It’s also important to note that this is not an anomaly that is limited to a few key sectors, the percentage of stocks with a payout ratio in excess of 60% of earnings per share has reached the highest level in 20 years. Click to enlarge As European investors have seen over the past few months, even those companies that were considered dividend aristocrats aren’t in any way immune from payout cuts, with companies like Rolls Royce ( OTCPK:RYCEF ), BHP (NYSE: BHP ), EDF, RWE ( OTCPK:RWEOY ) and Repsol ( OTCQX:REPYY ) all cutting their dividends during the past six months. An updated study This isn’t the first time Morgan has investigated this question. Back in 2008, the bank conducted a similar research exercise and found that dividend cuts can indicate powerful inflection points in share prices. At the time, the research showed that investors could do well by buying stocks on dividend reductions, particularly those that are stressed. In the 2008 version, Morgan’s research showed that UK companies that cut their dividend tended to outperform thereafter, especially if the shares had previously been poor performers, the payout cut was large or the starting yield was high. Click to enlarge In this updated version, Morgan examines 372 instances of dividend cuts in Europe over the last ten years. The stocks are based on the current constituents of MSCI Europe IMI, with a current market cap bigger than $2 billion. To qualify as a dividend cut, the company’s dividend payout has to be reduced by 5% or more. Should you buy a company after a dividend cut? The results of this study are rather interesting. It appears that dividend cuts are indeed, often inflection points for stock performance. Morgan’s research on the 372 instances of dividend cuts in Europe over the last ten years shows that the median stock underperforms the market by 19% in the preceding 12 months but then outperforms by 11% in the subsequent 12 months, and by 19% by the end of year two. The probability of a stock beating the market in the following 12 months after a dividend cut is 65%, and 66% of the subsequent 24 months. Click to enlarge The research also showed that the strongest outperformance comes from stocks where the dividend yield ahead of the cut was 12% or higher with a hit ratio of 83% in the subsequent 12 months and 88% in the following 24 months. The weakest performance came from stocks trading on a dividend yield of 4% to 6% ahead of the announced cut. Stocks that underperformed the market ahead of the dividend cut announcement tended to outperform the most after a cut. Among the stocks that underperformed more than 60% prior to the cut, 74% outperformed on a 12m basis and 86% outperformed on a 24m basis. The weakest subsequent performance came from the group that underperformed less than 20%, with a hit ratio of 61%, even on a two-year basis. Click to enlarge And lastly, the size of the dividend cut has an effect on performance after the event. In the 372 cases studied by Morgan’s analysts, the average dividend cut is more than 80%. Stocks that cut their payouts by more than 60% outperformed the most post the cut. The weakest performing group is the one that cut the dividend by 20% to 40% – even on a 2-year view, only 56% of such companies outperformed the market. Click to enlarge Dividend Cut – The bottom line All in all, this analysis from Morgan presents a pretty compelling argument: investors should buy stocks on dividend cuts, particularly those that have underperformed significantly ahead of the announced dividend cut, that previously had a very high yield, and those that cut their dividend by 60% or more. This analysis is aimed at European investors and Morgan also provide some investment ideas in the form of stocks that cut their dividends in the last year and are ‘stressed’. Click to enlarge Disclosure: None