American quality still at the highest profitability and valuation discounts since launch

By 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 US Quality Dividend Growth Index (WTDGI) selects companies that appear attractive based on measures of profitability such as ROE and ROA, and earnings growth prospects, and weights them according to their dividend stream. The WisdomTree US Quality 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 biggest dividend payers in the S&P 500 Index, 18 have increased their payouts 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 stock companies that were not eligible for inclusion in the WTDGI underscored 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 maximizing capital efficiency through dividends and share buybacks. 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.

Fundamentals

After its annual replenishment, WTDGI has improved both its profitability and its valuation measures. ROA improved to 8.50% and ROE improved by over 100 basis points to 28.75%. Both significantly outperform comparable measures of the S&P 500 Index.

Along with improved quality metrics, the post-rebalancing basket shows higher implied growth as measured by ROE earnings retention times. The WTDGI also has a dividend yield 0.84% ​​higher than that of the S&P 500 with a 13% discount on the forward valuation:

The WTDGI is trading at its largest forward valuation discount to the S&P 500 index since its inception in April 2013. The chart below shows how the P / E ratio discount and ROE premium, on the right axis, remain at attractive historical levels. .

Sector exposure

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.

Conclusion

Heading into 2022 with an eye out for volatility in the latter part of the economic recovery, we believe that exposure to a basket focused on profitability and growth fundamentals can provide investors with better market-adjusted returns. risk.

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.

References to specific securities and their issuers are for illustration purposes only and are not intended to be, and should not be construed as, recommendations to buy or sell such securities.

Learn more at ETFtrends.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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