Positive Earnings Season Is The Next Catalyst For DVY

| About: iShares Select (DVY)

The purpose of this article is to determine the attractiveness of "iShares Dow Jones Select Dividend (NYSEARCA:DVY)" as an investment option. To do so, I will review DVY's recent performance, current holdings and weightings, common metrics such as dividend yield and growth, and trends in the general market to attempt to determine where the ETF may be headed from here.

First, a little about DVY. The Fund seeks investment results that correspond with the price and yield performance of the Dow Jones U.S. Select Dividend Index. The Index is generally made up of companies with relatively high dividend yields and that have maintained these yields for a long stretch of time. Because of its diversity and inclusion of only high dividend payers, DVY is representative of the general market and the DOW as a whole. As of 7/23, DVY is trading at $66.96/share and pays a quarterly dividend of $.54/share, which translates to an annual yield of 3.23%. Year to date the fund is up over 17%, excluding dividends, and over the past 52 weeks the stock is up over 18%, also excluding dividends. Below is a chart of the top 10 holdings of DVY, which make up over 20% of the fund's total weight:

Name % of Fund
Lorillard Inc (NYSE:LO) 3.54%
Lockheed Martin Corp (NYSE:LMT) 3.12%
Chevron Corp (NYSE:CVX) 2.19%
Philip Morris International. (NYSE:PM) 1.97%
Entergy Corp (NYSE:ETR) 1.95%
Kimberly-Clark Corp (NYSE:KMB) 1.75%
McDonald's Corp (NYSE:MCD) 1.73%
Watsco Inc (NYSE:WSO) 1.68%
Integrys Energy Group Inc (NYSE:TEG) 1.67%
ConocoPhillips (NYSE:COP) 1.55%
Total 21.14%

Here is a complete list of DVY's holdings.

Clearly, DVY has recently performed very strongly. While DVY, along with other dividend paying stocks, ETFs, and closed funds, faced some pressure over the last few months as bond yields rose, I still like this investment for the long-term for a few reasons. One, dividend paying stocks and ETFs do certainly compete with bonds among risk averse investors. However, fixed income and dividend paying are separate categories and most investors are only going to set aside a portion of their assets in cash and fixed income classes. While safety is still a key trend going forward, dividend funds such as DVY offer investors some relative stability and consistent income, but also offer the possibility of growth and stock appreciation. Investing in bonds can simply not match these benefits. Therefore, I see the flight away from these funds as overblown, and see continued interest in DVY and similar funds in the near and long term as investors focus on gaining exposure to large cap U.S. companies, the best performing asset class in the last few years.

Two, U.S. companies have been reporting strong earnings this quarter. So far this earnings season, six out of ten companies have surpassed Wall St's expectations. This bodes well for funds such as DVY because as earnings increase, PE ratios drop, making stock prices more attractively valued and giving the stock less downside. DVY, which is comprised of many of these companies that are beating earnings, is now trading with a PE ratio of just over 6. This is extremely cheap, both in relative terms and compared to what the fund has traded at over the last few years, usually in the 9 or 10 range. A shrinking PE is not always a good thing, but in this case I view it as immensely positive because the PE is declining due to increased earnings. Since the stock price is now being supported by its earnings at a lower level, that provides more upside potential and less downside risk for DVY.

Another reason I am bullish about DVY with regards to corporate earnings has to do with the massive amount of money on U.S. corporate balance sheets. With cash at record levels, and companies reluctant to hire more workers, many companies are resorting to dividend increases and stock buy backs to return profits to shareholders. The second scenario, increased dividends, will directly benefit DVY shareholders. One of the main reasons dividend stocks will fall out of favor will be because of increased bond yields. However, if dividends continue to increase, that will keep the spread between dividend yields and bond yields very similar to where it is now. This should encourage some investors, who were considering a shift in allocation away from dividend ETFs, to stay put.

My hypothesis seems likely considering the dividend history of the companies in this fund, for they are only included in this fund because of their consistent payouts. For example, Lorillard, the top weighted holding in DVY, increased its dividend by about 6% in 2013 from 2012. The next two companies by weight, Lockheed Martin and Chevron, both have higher dividend payouts year over year by 15% and 11%, respectively. Going further down the list you will see similar increases. With this trend, and with corporate cash levels continuing to rise, I expect dividend payouts to rise for the foreseeable future.

Bottom line: Dividend payers continue to be in style. As investors continue to seek safety, funds that specifically invest in high paying stocks, such as DVY, will perform strongly. Coupled with the fact that DVY has recently experienced a declining PE and beta (from .86 to .83), the stock seems especially well priced. As we continue in to earnings season, I see increased corporate profits and cash balances as absolute catalysts for DVY to move higher. As yields rise across the board, DVY will surely benefit and reward current shareholders. With more expected increases on the way, I would advise investors to continue to look seriously at this fund.

Disclosure: I am long DVY. 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.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .