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Monday February 06, 2012
Select Dividend for equity income
by Benjamin Shepherd, editor Wall Street For just the second time since 1947, the dividend yield on the S&P 500 exceeds the yield on 10-year US Treasury notes. The S&P 500 currently yields 2.2 percent, while 10-year Treasuries yield just 1.85 percent. The last time this scenario occurred was during the 2008-09 financial crisis, so that suggests investors are extremely skeptical about equities’ future growth prospects. Although it’s difficult to find value among bonds in such an environment, equity-income funds still offer decent values. Among equity-income exchange-traded funds, I favor iShares Dow Jones Select Dividend Index (DVY). The ETF yields 3.4 percent and its average daily trading volume offers ample liquidity. 
The ETF tracks the Dow Jones US Select Dividend Index, a basket of the 100 highest-yielding stocks in the Dow Jones US Index. But stocks aren’t selected for the index solely on the basis of yield, they also must pass a number of qualitative screens. The first screen removes names that have dividend-per-share ratios below their five-year average. The next step eliminates stocks with payout ratios of greater than 60 percent. From there, the screening process removes any stocks whose history of paying dividends is less than five years, as well as any stocks whose average daily trading volume is below 200,000 shares. Once the screening process is complete, the index is created using a yield-weighted methodology, with no position exceeding 10 percent of assets. The selection process is then repeated each December. The fund’s focus on yield means that its holdings skew toward value names. Additionally, the ETF’s portfolio has a substantial tilt toward smaller-cap stocks: mid-cap stocks comprise more than a third of assets, and small caps comprise 14.9 percent of assets. From a sector perspective, the fund’s three largest allocations are to utilities (31.1 percent of assets), consumer staples (15.9 percent) and industrials (14.9 percent). These are cyclical sectors, so the ETF can suffer heavy losses during economic downturns. Despite the greater risk resulting from its smaller-cap, cyclical holdings, the ETF’s yield and its low 0.40 percent expense ratio make it an excellent option for long-term investors. Learn more about this financial newsletter at Benjamin Shepherd's Wall Street. 
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