ProShares S&P MidCap 400 Dividend Aristocrats: A Crown Jewel?

| About: ProShares S&P (REGL)

Summary

Dividend reinvestment is a powerful investment strategy.

A dividend-focused index tracking fund mitigates risks through diversification and the index’s inclusion requirements.

The holdings are mostly core components of their respective industries.

According to Investopedia "A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of shareholders. Dividends can be issued as cash payments, as shares of stock, or other property." The definition is deceptively simple since it doesn't take into account the power of dividend reinvesting. By automatically reinvesting distributions or dividends, your long-term return is compounded, greatly increasing the overall return of the holding. Here's an example: let's use a stock that pays a trailing-twelve-month dividend of, say, 2.00% and an entry price of, say $45.50 per share. Let's say you purchased 100 shares and you have, say, 20 years until retirement. Using one of the many available dividend reinvestment calculators (your online broker should have one) simply plug in the numbers. In fact, let's assume that the yield doesn't even increase over that time. Well, then your initial investment was $4550 and on that magic first day of retirement you look at your statement and behold! Your gain on that initial investment is $2,211.06 or in percentage terms, 48.59%!

This example has been greatly simplified. The yield is fixed, the number of shares is fixed and capital appreciation isn't taken into account; i.e., so this does not even represent the total return. Just think for a moment. Imagine what might be achieved by adding to your position by dollar cost averaging over many years. Also, there's a good chance that the dividend might increase over those 20 years. Many companies take pride by continually increasing their dividend.

Now keep in mind that markets tend to 'misbehave' so stock prices fluctuate, or dividends may be reduced or skipped or the company might be acquired for shares of another company which doesn't pay a dividend. In fact, if the stock price doesn't keep up with the rate of inflation, it will offset the real inflation-adjusted return.

So although you might agree with the power of dividend reinvestment, you might not feel confident in your ability to select the right company for the next couple of decades let alone the next couple of years; there's a heck of lot that can go wrong. Fortunately, there's a really good way to reduce your risk through a passively managed, dividend-focused ETF. There are some really good reasons for this. First, the tracking index will 'swap out' those companies which fail to meet the standards for inclusion in such a way so that index value is unchanged. Also, by holding a dividend-focused ETF, you're not just counting on one stock, but a portfolio diversified over many industries.

There are many well performing dividend-focused ETF choices. However, one of the better performing newly listed ETFs is based on the S&P MidCap 400® Dividend Aristocrats Index. It's offered by ProShares and named for the index: ProShares S&P MidCap 400 Dividend Aristocrats ETF (NYSEARCA:REGL). The first important observation is the index's inclusion standards:

"... Invests exclusively in S&P MidCap 400 companies with the longest track records of year-over-year dividend growth... ...Invest in a minimum of 40 stocks that are equally weighted. Because each stock is treated as a distinct opportunity without regard to market capitalization performance is not overly dependent on a few holdings..."

Click to enlarge

This investment thesis eliminates many of the risks that an investor would carry by selecting and managing just a few dividend paying companies no matter how good they are. It should be noted, however, the fund more 'closely weights' holdings and is not equally weighted by definition. The heaviest weighting is 5.77% and the lightest 0.68%. The average weighting is then 3.225%. According to the fact sheet, the fund rebalances four times a year and the next scheduled rebalancing is in July.

Performance

1 Month

3 Month

6 Month

Year to Date

1 Year

Since 2/3/2015

Inception

Market Price

0.91%

15.43%

8.64%

11.76%

11.94%

9.37%

NAV

1.09%

15.36%

8.63%

12.01%

12.19%

9.29%

Click to enlarge

Data from ProShares

The three-month average trading volume is good at just over 29,000 shares per day. The 30-day yield after expenses (SEC Yield) is 1.80%, a P/E ratio of 20.62, slightly above the current S&P 500 P/E; trades at 2.64 times book value and a trailing 12-month yield at 1.54%. Lastly, the expense ratio is 0.40%; about average for ETFs.

Now the first thing some investors might notice is the relatively low yields. Keep in mind that this fund represents the best of the S&P 400. As the US Federal Reserve continues to normalize, yields will have to become more competitive. On the other hand, if high quality fixed income yields remain the same or decline, the fund's share price is likely to increase due to the capital appreciation of the holdings. An argument can be made for a higher yield fixed income fund but over the long term there are obvious risks especially if inflation accelerates and treasury yields increase.

Although the fund equally weights market cap, it does diversify over sectors. The financial sector is top-weighted, followed by the traditional dividend paying Utilities. Technology and Healthcare are the least weighted sectors.

Data from ProShares

The financials include companies such as Old Republic (NYSE: ORI) a diversified, international holding company with 128 subsidiaries including a full spectrum of insurance coverage companies. Tanger Factory Outlet (NYSE: SKT) may sound like a Consumer Discretionary holding, but it's actually a commercial REIT focusing on shopping malls.

Financials 30.42850%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Old Republic Intl

5.76917%

$4.890

3.95%

$0.75

$2.843

26.381%

75.80%

Brown & Brown

(NYSE: BRO)

3.03355%

$4.940

1.39%

$0.49

$2.689

18.222%

74.20%

Eaton Vance

(NYSE: EV)

2.93008%

$3.840

3.03%

$1.06

$4.329

24.486%

76.30%

Tanger Factory Outlet

2.92322%

$3.310

3.65%

$1.30

$2.234

58.192%

96.00%

Bank Of The Ozarks

(NASDAQ: OZRK)

2.40369%

$3.320

1.71%

$0.62

$2.344

26.451%

89.49%

National Retail Properties

(NYSE: NNN)

2.39188%

$6.740

3.73%

$1.74

$1.709

101.838%

95.70%

Commerce Bancshares

(NASDAQ:CBSH)

2.23004%

$4.560

1.91%

$0.90

$3.110

28.939%

63.80%

SEI Investments

(NASDAQ: SEIC)

2.14767%

$7.830

1.08%

$0.52

$1.284

40.498%

70.30%

Prosperity Bancshares

(NYSE: PB)

2.03352%

$3.480

2.48%

$1.20

$4.368

27.474%

77.43%

Mercury General

(NYSE: MCY)

1.95115%

$2.870

4.79%

$2.48

$0.960

258.333%

45.50%

Cullen/Frost Bankers

(NYSE: CFR)

1.70571%

$3.710

3.51%

$2.16

$4.903

44.065%

78.90%

RenaissanceRe Holdings

(NYSE: RNR)

0.90882%

$4.910

1.09%

$1.24

$2.168

57.196%

96.10%

Averages

30.42850%

$4.533

2.69%

$1.21

$2.745

59.339%

78.29%

Click to enlarge

Data from Yahoo! Finance and Reuters

Utilities 27.74847%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

MDU Resources Group

(NYSE: MDU)

5.37393%

$4.270

3.49%

$0.75

-$0.762

NMF

63.70%

Black Hills

(NYSE: BKH)

4.85360%

$3.120

2.78%

$1.68

$0.201

835.820%

78.40%

Questar

(NYSE: STR)

4.20755%

$4.400

3.52%

$0.88

$1.020

86.275%

78.30%

Aqua America

(NYSE: WTR)

3.41333%

$5.790

2.18%

$0.71

-$0.282

NMF

48.80%

UGI Corporation

(NYSE: UGI)

2.63900%

$7.270

2.26%

$0.95

$3.216

29.539%

79.00%

Vectren

(NYSE: VVC)

2.20939%

$4.140

3.20%

$1.60

-$0.364

NMF

64.30%

National Fuel Gas

(NYSE: NFG)

1.99283%

$4.600

2.89%

$1.58

-$4.354

NMF

70.30%

WGL Holdings

(NYSE: WGL)

1.58311%

$3.450

2.85%

$1.95

-$3.520

NMF

65.00%

Atmos Energy

(NYSE: ATO)

1.47574%

$7.590

2.26%

$1.68

-$4.930

NMF

69.20%

Averages

27.74847%

$4.959

2.83%

$1.31

-$1.086

68.56%

Click to enlarge

Data from Yahoo! Finance and Reuters

The Utility holdings include diversified companies such as MDU Resources Group and traditional energy companies such as natural gas distributer Questar or water resource distributer Aqua America. The Utility companies in this group are traditional, established service providers.

Industrials 13.7703%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Donaldson

(NYSE: DCI)

3.18572%

$4.350

2.11%

$0.68

$1.034

65.764%

81.60%

MSA Safety

(NYSE: MSA)

2.13288%

$1.800

2.70%

$1.29

$2.160

59.722%

61.80%

CLARCOR

(NYSE: CLC)

1.78709%

$2.790

1.56%

$0.88

$4.164

21.335%

4.90%

Lincoln Electric

(NASDAQ: LECO)

1.67234%

$4.200

2.13%

$1.28

$4.713

27.159%

67.70%

Nordson Corporation

(NASDAQ: NDSN)

1.33226%

$4.450

1.24%

$0.96

$3.723

25.786%

67.40%

A.O. Smith

(NYSE: AOS)

1.30894%

$6.900

1.23%

$0.96

$4.175

22.994%

94.30%

Graco

(NYSE: GGG)

1.30613%

$4.480

1.65%

$1.32

$3.124

42.254%

90.00%

Carlisle Cos

(NYSE: CSL)

1.04537%

$6.510

1.19%

$1.20

$7.130

16.830%

93.30%

Averages

13.77073%

$4.435

1.73%

$1.07

$3.778

35.230%

70.13%

Click to enlarge

Data from Yahoo! Finance and Reuters

Similarly, the industrial companies are rather traditional with holdings such as Donaldson which manufactures filtration solutions for compression engines, fluids, gases, air and many other applications for just about every industry. MSA Safety as the name suggests, manufactures safety devices for every industry as well as security and detection systems as well as consulting. A.O. Smith manufactures water heaters for home and industry under three brands.

To this point, Financials, Utilities and Industrials comprise just over 70% of the fund. The common thread is of course dividends, as well as traditional, focused companies which solidly service specialized niches with core products. However, that's precisely what should be looked for if an investor is filtering out dividend paying companies. They are cyclically 'tempered' and an earnings sustainable business model based on core products sold in both good and bad times.

Materials 10.16112%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Sonoco Products (NYSE: SON)

2.21685%

$4.660

3.13%

$1.48

$2.616

56.575%

68.00%

RPM Intl

(NYSE: RPM)

2.05189%

$6.640

2.22%

$1.10

$2.922

37.645%

74.50%

Bemis

(NYSE: BMS)

1.99862%

$4.680

2.37%

$1.16

$4.076

28.459%

75.80%

Albemarle Corporation

(NYSE: ALB)

1.58852%

$8.690

1.60%

$1.22

$1.976

61.741%

87.30%

AptarGroup

(NYSE: ATR)

1.32022%

$4.880

1.70%

$1.12

$2.601

43.060%

88.90%

Valspar Corporation

(NYSE: VAL)

0.98502%

$8.480

1.23%

$1.32

$3.610

36.565%

78.90%

Averages

10.16112%

$6.338

2.04%

$1.23

$2.967

44.008%

78.90%

Click to enlarge

Data from Yahoo! Finance and Reuters

The Materials companies fall into that same category with companies like Sonoco Products which specializes in packaging, retail store display, storage, metal container top seals, reels, spools, rigid paper packaging and a host of other products. Also included is the well-known paint and coating manufacturer Valspar.

Consumer Discretionary 5.29399%

Weight

Market Cap (in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Meredith Corporation

(NYSE: MDP)

2.16496%

$2.190

4.04%

$1.98

$4.845

40.867%

98.10%

John Wiley & Sons

(NYSE: JW.A)

2.08274%

$2.910

1.80%

$0.80

$3.657

21.876%

5.70%

Polaris Industries (NYSE: PII)

1.04629%

$5.440

2.63%

$2.20

$6.752

32.583%

84.50%

Averages

5.29399%

$3.513

2.82%

$1.66

$5.085

31.775%

62.77%

Click to enlarge

Data from Yahoo! Finance and Reuters

Consumer Discretionary includes well known, well established media companies like John Wiley (NYSE: JW; Class A Shares). Polaris Ind manufactures off-road vehicles such as snowmobiles, small gas or electric transport for industry and government and of course, motorcycles. Consumer discretionary is certainly cyclic, however it accounts for about 5.3% of the fund.

Consumer Staples 4.88770%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Tootsie Roll Industries (NYSE: TR)

2.97610%

$2.200

3.84%

$1.35

$1.531

88.178%

35.90%

Lancaster Colony

(NASDAQ: LANC)

0.95759%

$3.400

1.64%

$2.00

$4.761

42.008%

54.10%

Casey's General Stores (NASDAQ: CASY)

0.95401%

$4.530

0.76%

$0.88

$0.300

293.333%

88.20%

Averages

4.88770%

$3.377

2.08%

$1.41

$2.197

141.173%

59.40%

Click to enlarge

Data from Yahoo! Finance and Reuters

Consumer Staples include two well-known food products distributors, Tootsie Roll and Lancaster Colony each with multiple brand names and a popular US Mid-West convenience store chain Casey's General Stores. Surprisingly, Consumer Staples comprise a mere 4.88% of the fund, but again, the fund tracks the S&P 400, and not S&P 500 where the consumer staple giants reside in the top 100.

Technology 5.73016%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Telephone and Data Systems (NYSE: TDS)

3.51955%

$3.050

2.13%

$0.59

-$5.290

NMF

87.50%

CDK Global (NYSE: CDK)

2.21061%

$8.050

1.05%

$0.54

$1.754

30.787%

76.60%

Averages

5.73016%

$5.550

1.59%

$0.57

-$1.768

*30.787%

Data only available for CDK

82.05%

Click to enlarge

Data from Yahoo! Finance and Reuters

Health Care 4.30036%

Weight

Market Cap

(in USD billions)

Yield

Dividend

Levered Free Cash Flow Per Share

Div/LFCF

Institutional Interest

Owens & Minor

(NYSE: OMI)

2.84610%

$2.300

2.80%

$1.02

-$0.107

NMF

NMF

West Pharmaceutical Services (NYSE: WST)

1.45426%

$5.250

0.67%

$0.48

$0.869

55.236%

86.20%

Averages

4.30036%

$3.775

1.74%

$0.75

$0.381

*55.236% Data only available for WST

*86.20%

Data only

available for

WST

Click to enlarge

Data from Yahoo! Finance and Reuters

CDK Global, a data analytics and information technology company, focuses on digital marketing solutions specifically for the retail automotive industry. Lastly, the healthcare holdings include one pharmaceutical and one healthcare 'logistics' company which 'connects' medical supplies to point of care providers.

Summary

Market Cap

(in USD billions)

Company Yield

Dividend

Levered Free Cash

Flow Per Share

Div/LFCF

Institutional Interest

Averages

$4.872

1.96%

$1.168

$2.60243

74.88%

73.42%

Click to enlarge

One note: An important metric for dividend sustainability is the payout ratio: which by definition is the proportion of earnings paid out as dividends. However, this metric is often absent from public domain information. Hence, another metric is utilized here: Dividend to Levered Free Cash Flow. By definition Levered Free Cash Flow "...is the free cash flow that remains after a company has paid its obligations on debt..." In particular, "...represents the amount of cash flow left over for stockholders and investments after all obligations are covered..."

So the ratio when compared with a group average gives a good idea of the sustainability of dividend. It isn't perfect, for example Utilities often have terrible cash flow metrics and usually carry higher debt. But for the purposes of getting an idea whether a dividend is too high or too low, it usually works pretty well. In the case of this fund, the average dividend to levered free cash flow is a bit high, but sustainable at almost 75% and is skewed higher by the utility holdings.

In other words, about 75% of the cash flow remaining after debt obligations are taken care of is distributed to shareholders.

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.

Additional disclosure: CFDs, spread-betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.