SDY: A Must-Own ETF For 2014

Dec. 2.13 | About: SPDR Dividend (SDY)

This article will discuss the importance of holding dividend stocks in your portfolio going into 2014. Dividend paying stocks tend to outperform any other general investment class in the long run and generally have low betas. They tend to do particularly well during bear markets and periods of high volatility. With that in mind, there is also downside risk as they may underperform during bull markets. However, that has not been the case in the current bull market (GE 29% up YTD, KMB 29.1% up YTD). Nevertheless, the climb in the market over the past year makes me think it is necessary to come back to safer assets, such as dividend paying stocks. Let's take a look at why investors should consider reevaluating investment strategies going into 2014.

While YTD S&P 500 earnings are up around 7%, the S&P500 index is up 26.6% over the same period. Based on these figures, one could make the argument that the market is due for a correction. The economy has had a decent recovery during the last year or so, but the market appears to be overreacting to the recovery. So what makes up for the nearly 20% spread between earnings and stock prices growth? In my opinion, it is a combination of two main factors: cheap money by the Federal Reserve and strong investor confidence. However, current levels of quantitative easing by the Fed are not sustainable over the long-run. In fact, there has been talk over the last few weeks that the Fed may begin tapering quantitative easing in the coming months. In such a scenario, it is unlikely that investor confidence alone will sustain the stock market at its current levels.

One sound investment option based on the previous analysis is SDY. SDY is an ETF that tracks large cap dividend payers in the DJI and S&P 500. SDY is probably my favorite ETF because it only holds stocks that have raised their dividend payouts every year for the last 25 years. This is an excellent way to secure quarterly dividend payments. Also, the companies that make up SDY have had strong performance during ups and downs in the market. Here is a list of the top holdings of the fund:

NAME WEIGHT
AT&T Inc. (NYSE:T) 3.01%
HCP Inc. (NYSE:HCP) 2.51%
Consolidated Edison Inc. (NYSE:ED) 2.40%
National Retail Properties Inc. (NYSE:NNN) 2.24%
Kimberly-Clark Corporation (NYSE:KMB) 2.10%
The Clorox Company (NYSE:CLX) 2.10%
AbbVie Inc. (NYSE:ABBV) 2.09%
Sysco Corporation (NYSE:SYY) 2.05%
McDonald's Corporation (NYSE:MCD) 1.91%
Chevron Corporation (NYSE:CVX) 1.88%
Click to enlarge

SDY currently has a dividend of approximately 2.24% and a beta of 0.76, meaning it is less volatile than the market as a whole. Its P/E ratio is close to 18, which suggests there is still room for the fund to move higher. Furthermore, as the following graph shows, SDY is currently over its 200-day moving average which is a bullish signal.

SDY Price MovementSDY Price Movement

Considering that the market continues to go higher and that it is likely to continue this trend through the holiday season, I would recommend starting with a small position in SDY and continuing to grow it going into 2014.

Another reason why I recommend SDY as an investment option is that it has an expense ratio of 0.35%, meaning the fund will cost you $3.50 in annual fees for every $1,000 you invest. According to the Wall Street Journal, the average expense ratio for a given ETF is 0.44%. Management fees have a direct impact on your return and therefore they are an important factor to consider. From a diversification perspective, SDY has no more than 3% invested in a particular stock, and it is well diversified across industries. The following chart highlights its top five sectors:

SDY is also weighted between 8% to 9% on health care, and consumer discretionary. In summary, SDY covers all the major industries and has exposure to the sectors that are known to have solid positive cash flows and reliable dividends, precisely the stocks that perform well when there is a pullback.

Finally, it is important to keep in mind that the SDY dividend payout depends on the performance of the companies that comprise the fund. That means that the dividend will move up and down depending on whether those companies decide to increase or decrease their dividends. Even though SDY mitigates some of this risk by only holding stocks that have raised payouts for the last 25 years, dividend cuts are still possible. In my opinion, a decreasing dividend scenario is unlikely given that companies are generating healthy amounts of cash, but if such a scenario does occur, it would lower the attractiveness of SDY as an investment option.

Sources: Yahoo Finance, The Wall Street Journal, sprds.com

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SDY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.