American quality still at the highest profitability and valuation discounts since launch
Through Alejandro Saltiel, CFA
Associate Director, Research
Quality stocks have lagged around the world this year, as expected in the early stages of an economic recovery.
the WisdomTree American Grade Dividend Growth Index (WTDGI) selects companies that appear attractive based on profitability metrics such as DEER and ROA, and earnings growth prospects, and weights them by their dividend stream. the WisdomTree American-Grade Dividend Growth Fund (DGRW), seeks to track the price and performance of WTDGI, before fees and expenses.
Its fundamental strategy has allowed WTDGI to gain exposure to dividend producers and avoid exposure to companies that risk reducing or suspending dividend payments.
After a year of stable dividend growth, economic growth this year supports dividend growth across all industries. Of the 20 largest dividend payers in the S&P 500 Index, 18 have increased their payments in the past 12 months.1 Banks, which have been blocked by regulators from increasing payments in 2020 due to the COVID-19 pandemic, are among the most dynamic. Excluding banks, WTDGI held more than half of the 20 biggest dividend producers in the S&P 500 Index in 2021.
Methodology update – The rise of intangible assets
The WTDGI is rebalanced annually in order to reset exposure to these companies and to adapt to changing economic conditions. Ahead of this year’s replenishment, we announced an update to the WTDGI methodology, improving our original process created over eight years ago. The growing number of negative equity companies not eligible for inclusion in the WTDGI stressed the need for an update.
Since 2017, the number of companies with negative equity capital has grown steadily: today, more than 30 companies in the S&P 500 fall under this classification. This is in part due to undervalued assets on their balance sheets (brand value, patents, real estate values, etc.) and the maximization of capital efficiency through dividends and stocks. redemptions. Companies with negative equity are typically involved in franchising, data or real estate activities or are companies with large research and development budgets.
Some of these companies have strong business models and histories of dividend growth, as shown in the table below. As the number of negative equity companies continues to increase, we wanted to update the methodology to give them a fair chance to be included in WTDGI.
WTDGI selects eligible companies using a weighted combination of three factors: estimated medium-term earnings growth, three-year historical average ROE, and three-year historical average ROA. This most recent update gives companies with negative equity a median ROE score if they have had positive dividend growth in the past five years, making them eligible for inclusion if their growth and their ROA justifies it.
Here are some of the major changes after the reenactment of WTDGI in December.
After its annual replenishment, WTDGI improved both its profitability and Evaluation metric. ROA improved to 8.50% and ROE improved by over 100 basis points at 28.75%. Both significantly outperform comparable measures of the S&P 500 Index.
Along with improving quality measurements, post-rebalancing basket shows higher implicit growth, measured by retention of earnings times ROE. WTDGI also has a 0.84% higher dividend yield than the S&P 500 with a 13% discount in forward valuation:
WTDGI is trading at its greatest term valuation discount against the S&P 500 Index since its inception in April 2013. The chart below shows how the two P / E ratio discount and ROE bonus, on the right axis, remain at attractive historical levels.
During this latest replenishment, the consumer discretionary sector saw the biggest increase in weight, as the economy continued to rebound from the COVID-19 slowdown last year. Adding negative equity but major dividend producers like Home Depot, McDonald’s and Starbucks led the way. The consumer staples sector also saw its exposure increase with the addition of Philip Morris and Kimberly-Clark Corporation.
Noticeable weight reduction came from the healthcare and information technology sectors. Companies with significant weight reductions were Pfizer, Bristol-Myers Squibb, and Intel Corp.
The sector’s overall tilt against the S&P 500 Index remains constant, with WTDGI remaining underweight Financials and Consumer Discretionary while being overweight Industrials, Healthcare and Consumer Staples.
On the way to 2022 with an eye on volatility in the latter part of the economic recovery, we believe that exposure to a basket focused on profitability and growth fundamentals may provide investors with better risk-adjusted returns.
1 Sources: WisdomTree, FactSet. Data from 11/30/20 to 11/30/21.
Significant risks associated with this article
There are risks associated with investing, including possible loss of capital. Funds focusing their investments on certain sectors increase their vulnerability to any economic or regulatory development. This can lead to greater volatility in the price of the shares. Dividends are not guaranteed and a company that currently pays dividends may stop paying dividends at any time. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
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