The Rush to Yield Has Bid Up Valuations
Mark Twain once quipped, “Whenever you find yourself on the side of the majority, it is time to pause and reflect.” For investors in this low-yield environment, there has been an almost insatiable appetite for financial assets yielding above, well, zero. Alas, the search for yield has driven valuations in particular parts of the market to levels that we view as unsustainable.
It’s time to pause and reflect before rushing to follow the crowd.
The habitually uninteresting utilities sector is trading at a price-to-sales ratio of 2, compared with a 25-year average ratio of 1.2 (Exhibit 1). At a ratio of 2, the utility sector is near its all-time high in valuation, even after the 10% correction that commenced in early July. Yet popular low-volatility ETF strategies still currently hold more than 20% of their portfolios in the utility sector.
Accessing Yield at Lower Valuations Through Revenue Weighting
Our Ultra Dividend Revenue strategy is designed to provide exposure to companies with attractive dividend yields and typically with a history of growing their dividends. More importantly, it employs a weighting methodology that is designed to systematically pull the portfolio away from overvalued sectors, industries and companies.
In short, we seek yield at reasonable prices. How do we do it? Each quarter we take the top 60 dividend-yielding companies within the S&P 500 Index and the S&P 400 Index (also known as the S&P 900 Index) and then weight them on the basis of trailing 12-month revenues.
By way of example, consider our exposure to the utilities sector. At the start of the year our strategy, much like the low-volatility strategies, held nearly 25% of its portfolio in this sector. We benefitted significantly from this allocation when the sector surged as the 10-Year Treasury rates fell from 2.25% at the start of the year to below 1.40% by the end of June. As stock prices in the utilities sector were bid up, their dividend yields (i.e., dividend per share divided by the share price) fell drastically. By the time we rebalanced in early July, fewer utility companies were left among the top 60 dividend yielders of the S&P 900 Index. Our exposure had been more than halved.
This systematic rebalancing enabled us to buy positions in the utilities sector at lower prices at the beginning of the year and to eliminate many of the positions when the prices of utility stocks rose and the dividend yields plunged. As a result, the Ultra Dividend Revenue strategy has outperformed the S&P 500 Utilities Sector and the S&P 500 Low Volatility Index by 1,357 basis points and 826 basis points, respectively, since the July 6, 2016 peak in the utilities sector1 (Exhibit 2).
Past Performance Does Not Guarantee Future Results.
This latest rebalancing has resulted in our largest current exposure to consumer discretionary names, which in general have not participated as much in this year’s rally and are currently trading at a price-to-sales ratio of 1.4, a level only slightly above the sector’s long-term average. Again, our systematic rebalancing has led us to allocate to companies that appear more attractively priced.
As a result of this rebalancing, which is consistent with our methodology, the portfolio is yielding 3.5% but trading at a price-to-sales ratio of 0.6. Compare that with the utilities sector (at a yield of 3.5% and price-to-sales ratio of 2), low-volatility strategies (at a yield of 2% and price-to-sales ratio of 1.8), or even the broad S&P 500 Index (at a yield of 2.1% and price-to-sales ratio of 1.9), and what you’ll find is that our Ultra Dividend Revenue strategy is a higher-yielding and more attractively valued portfolio (Exhibit 3).
Price-to-sales ratios are very good indicators of long-term future returns. If you can build a portfolio with a lower ratio, you are likely to benefit over time.
Be wary of overvalued dividend-yield strategies. The herd mentality rarely ends well. As Charlie Munger said, “Mimicking the herd invites regression to the mean.” We may already be witnessing the beginning of such a regression.
|As of 9/30/16||YTD||1-Year||3-Year||5-Year||Life|
|Ultra Dividend Revenue ETF NAV||20.86||22.65||13.32||13.32|
|Ultra Dividend Revenue ETF MKT||20.93||22.72||13.32||13.32|
Gross expense ratio: 0.72%. Net expense ratio: 0.49%. Inception date is 9/30/13.
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so an investor’s shares, when redeemed, may be worth more or less than the original cost. For the Fund’s most recent month end performance please visit www.revenueshares.com. The net expense ratio takes into account contractual fee waivers and/or expense reimbursements, without which performance would have been less. These undertakings may not be amended or withdrawn for one year from the date of the current prospectus.
The NAV return is based on the net asset value of the Fund and the market return (MKT) is based on the market price per share of the Fund. The price used to calculate MKT is determined by using the midpoint between the highest bid and the lowest offer on the primary stock exchange on which the shares of the Fund are listed for trading when the Fund’s NAV is calculated at market close. MKT and NAV assume dividends and capital gain distributions have been reinvested in the Fund at market price and NAV, respectively. Returns less than one year are cumulative.
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1 As of October 7, 2016. Past performance does not guarantee future results.
The S&P 500 Index measures the performance of 500 widely held stocks in U.S. equity market.
The S&P 500 Low Volatility Index measures the performance of the 100 least volatile stocks in the S&P 500 based on their historical volatility.
The S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS utilities sector.
The S&P 900 Index is a combination of the S&P 500 Index and the S&P MidCap 400 Index and is intended to measure the performance of large- and mid-cap companies in the U.S. equity market. It consists of 900 domestic stocks chosen for market size, liquidity, and industry group representation and covers approximately 87% of the domestic equities market.
The indices are unmanaged, include the reinvestment of dividends and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
An investment in the funds is subject to investment risk, including the possible loss of the principal amount invested. There is no guarantee that the issuers of stocks will declare dividends in the future, or that dividends will remain at their current levels or increase over time. Fund returns may not match the return of its respective index, known as non-correlation risk, due to operating expenses incurred by the Fund. The alternate weighting approach employed by the funds (i.e., using revenues as a weighting measure), while designed to enhance potential returns, may not produce the desired results. Because the funds are rebalanced quarterly, portfolio turnover may exceed 100%. The greater the portfolio turnover, the greater the transaction costs, which could have an adverse effect on Fund performance.
These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.