TDIV: High-Dividend Yields Come From The Tech Sector Too

| About: First Trust (TDIV)

Summary

The First Trust NASDAQ Technology Dividend Index Fund is profiled.

The fund's 2.9% yield easily tops the 2.1% yield of the S&P 500.

The fund is a concentrated mega-cap tech portfolio with 40% of assets dedicated to the top five holdings.

Several valuation metrics suggest the fund is undervalued by about 5-10% compared to the S&P 500.

Many high dividend ETFs load up on utilities and consumer goods companies to generate income. While many of these stocks come with above average yields, these sectors are also getting stretched from a valuation perspective putting investors at risk for losing principal. It might be wise for investors to begin searching for other sources of income outside of these conservative, yet overpriced sectors. One intriguing option comes from a sector that isn't normally thought of as a high dividend area: technology.

The First Trust NASDAQ Technology Dividend Index Fund (NASDAQ:TDIV) focuses on technology and telecom companies that have paid and not decreased their dividend in the past 12 months and yield at least 0.5%. It's a relatively low bar to clear but historically the fund has done a much better job in delivering income to investors. The fund currently yields 2.9%, well above the S&P 500 (NYSEARCA:SPY) yield of 2.1%.

While the yield on the fund is no doubt attractive for investors seeking higher income from a sector that diversifies a broader portfolio, there are things to like about the fund and things that raise some yellow flags.

Relative Valuation

With a trailing 12 month P/E ratio of 19 and a forward P/E of 17-18 based on 2016 estimates, the S&P 500 is more on the expensive end that it has historically. Following their recent rallies, the utilities and consumer sectors are similarly overvalued at current levels. Five years ago, the utilities sector had a P/E of 12. Today, it's 17. The consumer staples sector was at 14. Today, it's around 21. The consumer discretionary sector was at 13. Now, it's at 18.

The traditionally growth-oriented technology sector now appears to be relatively undervalued. The Technology Dividend Index ETF has a P/E ratio of 15.6, a P/S ratio of 1.7 and a PEG ratio of 1.6. All are levels approximately 5-10% below that of the S&P 500. I don't necessarily think that a rally in tech stocks is imminent but I think the relative valuation of the sector provides a degree of downside protection in a way that the traditionally high yield sectors currently does not.

Portfolio Concentration

The fund's mandate calls for it to hold roughly 100 names at any given time but in reality it's a much more concentrated portfolio. Taking a look at the top 10 holdings of the fund, this is essentially nothing more than a concentrated mega-cap tech portfolio.

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The Technology Dividend Index ETF is a who's who of the biggest names in the tech sector. The top five names in the fund account for a full 40% of fund assets making it highly dependent on the performance of just a few companies.

Historically, that has not helped. Cisco (NASDAQ:CSCO) and Microsoft (NASDAQ:MSFT) have performed relatively well against both the S&P 500 and the Nasdaq Composite but the rest have been a significant drag on the fund. IBM (NYSE:IBM) has reported several straight years of falling revenues as it continues to work its way through a major transition from its traditional business model to newer revenue sources like cloud and security. Apple (NASDAQ:AAPL) is off about 26% from its 2015 highs amid signs that the smartphone market is reaching saturation and no clear next big revenue generator in sight. Intel (NASDAQ:INTC) continues to be impacted by a weak PC market as it tries to establish more sure footing in the mobile and tablet markets.

The result is a fund given just a 2-star rating from Morningstar. The fund has returned a total of about 47% since inception compared to a 61% return for the S&P 500 and a 70% return for the Nasdaq.

Dividend History

The fund doesn't necessarily target dividend aristocrats - AT&T (NYSE:T) is the only one of the top 10 holdings that qualifies - but several others have strong dividend histories. Qualcomm (NASDAQ:QCOM), Microsoft, IBM and Texas Instruments (NYSE:TXN) all have at least 10 years of growing their dividends.

Despite the dividend lineup, the fund has been relatively inconsistent in its quarterly dividend. In recent years, the quarterly dividend has been as little as $0.15 per share and as large as $0.25 per share. This fund won't necessarily be ideal for someone looking for regular portfolio income but the fund's overall dividend yield has been consistently higher than those of the major indices.

Conclusion

Given its concentration, the fund's performance will be highly dependent on the performance of just a handful of companies. Given the dividend resumes of several of the fund's largest holdings, it's reasonable to think that the above average dividend yields will continue but shareholders need to understand the nature of the concentrated portfolio.

The fund's 0.50% expense ratio is also higher than it should be. In a portfolio where nearly 60% of fund assets are dedicated to just 10 stocks, the fund should be much closer to the 10-20 basis point range that many other high dividend ETFs can be had for.

Overall, I like this fund for its above average dividend yield and risk-limiting possibilities. However, this portfolio is likely not for everybody and investors should be aware of what type of portfolio they're buying.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.