The Dow Jones Europe Forecasted Dividend Plus Index is a new dividend index with a couple of twists. It has not yet been tracked by an ETF but this is probably a matter of time, and I think it is also likely that an index with the same methodology is developed for U.S. or North American markets.
HOW THE DIVIDEND INDEX IS BUILT
To be eligible for inclusion in the index, a European stock must have a positive 12-month earnings per share, paid a dividend over the last three years, is forecast to continue paying dividends, and enjoys sufficient liquidity.
The list of stocks is then further narrowed down by ranking on highest forecasted dividend yields, likely dividend growth, and the stock performance over the last three months.
The top 40 stocks are selected and added to the index although, in order to avoid excessive turnover, incumbent stocks need only rank in the top 60 to retain their position in the index. To cap exposure, the maximum shares in the index from any one country is 15 while no company can represent more than 10% capitalization.
This process and review of the index is repeated every six months, in June and December, but a stock may be dropped from the index at any time if the company eliminates the dividend, if it is forecasted to do so, or there's corporate actions such as delisting or bankruptcy.
With interest rates kept at zero, dividend indices have come to the fore and many new ones are being created. The main dividend indices are already tracked by ETFs , who license the index for use from the index providers.
Index design has so far been in terms of segmenting the market between normal and high yield and providing indices for different markets and geographical regions.
Although the Dow Jones Europe Forecasted Dividend Plus Index is constrained geographically it takes an interesting approach because it takes in consideration (1) dividend forecasts made by analysts, (2) the extent to which future dividends are likely to grow, and, importantly (3) the momentum shown by the stock price.
(There are of course other momentum indices and ETFs, for example, the Russell-Axioma Developed ex-U.S. Large Cap High Momentum Index, and, in Canada, the XTF Morningstar Canada Momentum Index ETF, which has an indicated current dividend yield of 2.4%. )
Dividend investing is normally an aspect of value investing, where one is trying to buy a sustainable cash inflow at an attractive price, with low ratios of price to earnings, price to book, and price to sales, supported by a shareholder-friendly management and dividend payout ratios.
The role of investment adviser or portfolio manager is to show you where s/he thinks value lies, when to be patient (which is most of the time) and when to make your move.
This index takes a different approach to traditional dividend investing by taking its cues from the views of analysts about earnings and the views of market participants during the last three months as they push the market, and the company's shares price, up and down.
Research has found that analysts forecasts are influenced by market sentiment at the time the forecast is made, and so are the ups and downs in the market.
THE EVENTUAL ETF
Although I like this index, and I think it stands a good chance of performing well compared to market averages over the longer term, this double-link to market expectations removes some of the contrariness inherent in traditional dividend investing, such as that practiced by our firm.
An ETF set up to track this index should not face undue difficulties tracking the index and, if costs are kept low, should also have a good chance of turning in a good performance over a number of years and market cycles.
Such an ETF is likely to find a place in many dividend portfolios at least for two reasons.
- First, because markets have a tendency to trend and momentum investing works most of the time.
- Second, because if you are running a traditional dividend portfolio, it would help diversification if you have another dividend-oriented strategy contributing to your portfolio via a stand alone ETF tracking this new DJ transparent index. That's also why I think we will have a North American version of the index soon.
Dow Jones started calculating the index live on March 22nd, 2012, but it provides a table of back-tested performance on its Fact Sheet for the product.
The current top three countries in the Index are the U.K. (28%), Spain (12%), and Germany (9%). The sector with highest representation is Telecommunications, followed by Financials and Consumer Services.
Dow Jones recently published a "Talking Points" article about the index which shows how it picks different shares from the more traditional indices, such as the STOXX Europe Maximum Dividend 40.
The new index picked up Bilfinger Berger and BASF which are not included in the Max Div index and, conversely, excluded certain companies in the Max Div index, such as Nokia (NOK) and Veolia Environment (VE), which failed to make it due to poor stock price momentum and dividend growth rates.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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