Published October 24, 2012
Inflows to dividend ETFs are on a torrid pace this year. Combine that with the fact some sector ETF chock full of dividend stocks (think health care and telecommunications) are outperforming the broader market, and it is easy to see why some perceive dividend sectors to be richly valued.
In reality, that may not be the case, according to a note published by WisdomTree Research Director Jeremy Schwartz. On the basis of price-to-earnings ratios, some dividend sector ETFs do look like they are sporting lofty valuations. For example, the iShares Dow Jones U.S. Telecommunications Sector Index Fund (IYZ) has a P/E ratio north of 40. The Utilities Select Sector SPDR (XLU) features a P/E ratio of almost 15.3, indicating some stodgy utilities are trading at the upper end of their historical valuations.
However, P/E ratios are not the only metric investors need to be concerned with, as Schwartz notes.
"In my opinion, price-to-earnings ratios may not be the best estimates of whether the stocks within these sectors are reaching a bubble or not," he said in the note. Consider that since these indexes contain dividend-paying stocks, a better gauge might be the trailing 12-month yield, since it compares the prior 12-months' worth of dividend payments to the stock price."
The trailing 12-month yield, a stand-alone metric, is the percentage of income returned to portfolio over the past 12 months. It is calculated by taking the weighted average of the yields of the stocks and funds that compose the portfolio, according to Morningstar.
On that basis, telecommunications stocks and ETFs could still be offering some upside. The group had a 20-year average trailing 12-month dividend yield spread of 1.54 percent, but as of the end of August, that number was 2.7 percent.
"One could thus argue that this particular value is one of the more attractive spreads that these stocks have displayed over the last 20 years," according to Schwartz.
The 20-year historical spread for consumer staples was 0.32 percent, but rested at 0.68 percent at the end of August, implying value in that group as well. Year-to-date, the Consumer Staples Select Sector SPDR (XLP) is up 8.5 percent.
Schwartz said investors that view U.S. utilities as being too expensive should consider foreign equivalents, which are trading at discounts to U.S. rivals. Options to consider include the WisdomTree Global ex-US Utilities Fund (DBU). DBU, which is down slightly this year, has a 30-day SEC yield of 4.4 percent. Top country weights in the ETF include Brazil, Canada, Italy, the U.K. and France.
Those looking for international exposure to multiple dividend sectors under the umbrella of one ETF can consider the WisdomTree International LargeCap Dividend Fund (DOL). DOL has a 30-day SEC yield of 3.71 percent. Telecommunications, staples, health care and utilities combine for over 41 percent of that ETF's weight.
"As of August 31, 2012, health care exhibited a positive spread of .09%another spread level higher than its historical average, which signals a potentially attractive current valuation level," said Schwartz.
One U.S.-focused fund that offers ample exposure to the attractive spreads found among health care, staples and telecommunications names is the WisdomTree Equity Income Fund (DHS). Those three sectors combine for 51 percent of the ETF's weight, though it should be noted utilities receive an allocation of 13.6 percent. DHS has a 30-day SEC yield of 3.93 percent.
For more on dividend ETFs, click here.
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