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.

Exhibit 1: S&P 500 Utilities Sector Price to Sales -- OppenheimerFunds

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).

Exhibit 2: Performance Since July 6, 2016 Peak in Utilities Sector -- OppenheimerFunds

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).

Exhibit 3: Price To Sales and Dividend Yield of Common Dividend Strategies -- OppenheimerFunds

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 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.