TDIV: A Tech Play For 2020

Summary

  • TDIV is up double digits, and has beaten the S&P 500, since I recommended it earlier this year.
  • The fund's dividend focus gives investors a more conservative way to play one of the market's more expensive sectors.
  • There are signs investors are getting more value-conscious, which could favor funds like TDIV going forward.

Main Thesis

The purpose of this article is to evaluate the First Trust NASDAQ Technology Dividend Index ETF (NASDAQ:TDIV) as an investment option at its current market price. TDIV has been on my radar for a while, and is a good option for income-oriented investors who want to capture technology exposure. While the yield is relatively low, it is higher than technology sector ETFs, and offers investors exposure to more mature, dividend paying, and established companies within the tech space. Furthermore, TDIV, while not "cheap," has a valuation markedly below the broader technology sector. With investors seeming to favor value over growth in the short-term, this could work to TDIV's favor going forward. Finally, the underlying holdings within the fund continue to perform well. With consumers set to increase spending on items like wearable technology, headsets, and drones, the technology sector should continue to look attractive through 2020 and beyond.

Background

First, a little about TDIV. The fund "seeks investment results that correspond generally to the price and yield (before the Fund's fees and expenses) of an equity index called the NASDAQ Technology Dividend Index". To be included in the index, the security must have a minimum market capitalization of $500 million, have a minimum three-month average daily dollar trading volume of $1 million, have paid a regular or common dividend within the past 12 months (with a yield of at least 0.5%), and not decreased its dividend within the past 12 months, among other factors. Currently, TDIV trades at $40.87/share and yields 2.37% annually. I covered TDIV for the first time back in February, and recommended the fund as a safer way to play the technology sector. Looking back, this was a good call. The fund has returned almost 11%, while also out-performing the S&P 500 since that time, as shown below:

Source: Seeking Alpha

With this in mind, I wanted to reassess TDIV, to see if I should continue to recommend the fund heading in to the new year. After review, I continue to believe TDIV could be a core holding for an investor looking for both technology exposure and dividends, and I will explain why in detail below.

Technology Leads The Market, But Valuation Is Pricey

I want to start the article by discussing the primary reasons why I favor TDIV over buying a broader technology sector ETF. While TDIV does offer technology exposure exclusively, the dividend focus narrows the range of companies that could be included in the fund. As a "Dividend Seeker", I view this positively out of the gate, but I also believe this focus will serve investors well in the short-term especially given where the market sits right now.

Of course, I must first mention that technology as a whole has been out-performing this year, and TDIV's more conservative style has capped gains compared to the broader sector. For example, the Technology Select Sector SPDR Fund (XLK), which is a good benchmark for the technology sector, has seen its shares rise 34% this year. This easily bests what TDIV has returned in 2019, so investors may wonder why they would be better served going with a fund like TDIV. While XLK may certainly be preferred by some investors, for me, the rising cost to own it, especially when compared to TDIV, tells me now is a good time to be more cautious. To illustrate, consider the relevant metrics in the chart below:

Fund YTD Share Price Return P/E Ratio Dividend Yield Number of Holdings Weight of Top 10 Holdings Expense Ratio
TDIV 22% 17.0 2.37% 92 58% .50%
XLK 34% 21.5 1.24% 68 65% .13%

Source: First Trust; State Street

As you can see, while XLK has been outperforming TDIV this year, its P/E ratio is noticeably higher. Of course, there is the possibility that this divergence could continue. However, given that the market is sitting near all-time highs, I believe now is a good time to get a bit more conservative. For investors who want to remain long in the tech space, TDIV offers a better priced way to do it.

Furthermore, there are other metrics that seem to favor TDIV, from my point of view. One, despite being a more focused fund, TDIV appears more diversified than XLK. While TDIV has a lot more holdings than XLK, it is fairly top heavy, with roughly 58% of its total assets residing within just ten stocks. But that metric is lower than XLK's, which is even more concentrated at the top. Two, its dividend yield, which I put an emphasis on, clearly has an obvious advantage.

My takeaway here is that investors could be well served by branching away from broad-based technology ETFs, and in to a more focused approach like TDIV if the valuation of the technology sector concerns them. And with more holdings, less concentration at the top, and a higher dividend yield, TDIV has more than just a cheaper valuation going for it.

Investors Are Shifting To Value

Of course, simply having a lower P/E does not mean investors would suddenly start shifting in to funds like TDIV at the expense of XLK. There could be very valid reasons why XLK is commanding a premium price, and its short-term return could certainly prompt investors to keep bidding up the shares. However, I am seeing a bit of a turning point in the market, which makes me think TDIV's cheaper valuation is likely to come in handy.

Specifically, there has been a shift in investor interest in value stocks. While growth stocks have been winning post-recession, we have seen value outperform growth on a few occasions this year, including very recently, as shown in the graph below:

Source: Bloomberg

As you can see, value has started to sneak out a small gain (against growth), which makes logical sense to me given where the major indices are. While many headwinds remain, such as global trade issues, slowing global and domestic economic growth, and political uncertainty due to an upcoming U.S. presidential election, investors have continued to send equity prices higher. Given that we are back within striking distance of all-time highs, I believe value's recent resurgence could have some legs this time around.

Of course, TDIV is not a "value" fund, despite its relatively cheaper price compared to the technology sector. Therefore, this value outperformance I discussed above does not include funds like TDIV specifically. But my point here is that investors seem to be giving more thought to valuation, rather than growth potential, which is my main takeaway from the graph. While investors could prefer traditional "value" sectors in lieu of TDIV, I believe TDIV offers a great way to remain exposed to a faster-growing sector, while taking some risk off the table. Given investors' renewed concern for valuation, I feel this demand could extend beyond true "value" funds, and into funds that are relative values when compared to their peers, which should help TDIV.

Micro Look - Top Holdings Performing Well

I now want to turn to the underlying holdings of TDIV to discuss why I believe this fund is a good investment option. As I mentioned, the fund is quite "top heavy," with the top five companies making up over 40% of total assets, as shown below:

Source: First Trust

Therefore, it is especially important for investors to consider the underlying performance of these individual companies - Intel Corp (INTC), Apple (AAPL), Microsoft (MSFT), Cisco Systems (CSCO), and International Business Machines (IBM) - when evaluating TDIV. To give a current picture on how these companies are performing, I have reviewed the most recent financial filings for each company. Listed below are some relevant metrics based on their Q3 financial results:

Company Revenue Gain (YOY) Net Income Gain (YOY) YTD Share Price Gain Current Yield Forward P/E
INTC Flat (6.4)% 19% 2.24% 12
AAPL 1.8% (3.1)% 54% 1.27% 21
MSFT 13.7% 21.0% 41% 1.43% 27
CSCO 6.3% 15.5%* 10% 1.7% 14
IBM (3.9)% (39.9)% 16% 1.7% 10

Source: Seeking Alpha

*Net Income for CSCO was up substantially from 2018 due to a dramatic decrease in the provision for income taxes. Therefore, the author utilized the YOY gain in Operating Income for this metric to give investors a better sense of the extent of the company's performance improvement.

As you can see, these results are pretty solid, with the notable exception of IBM, which is a similar story to what we saw at the beginning of the year. Furthermore, even with companies like INTC seeing some pressure on a YOY basis, these firms are still reporting strong profit numbers isolation, which has helped support share prices. Also comforting is the fact that IBM and INTC, which have had some trouble growing net income figures, have valuations well below the TDIV average. This tells me these firms are priced appropriately, and could see marked upside if these income figures improve going forward.

My overall takeaway here is fairly positive. TDIV's top holdings are seeing strong share price moves, and overall exhibited solid earnings in Q3. With a collective valuation below the broader market's, I see plenty of reason to remain bullish on this fund.

Tech Products Are In Demand

My final point concerns the technology sector more broadly, and is focused on consumer demand. Simply, consumer spending on the products and services within the technology sector is expected to increase markedly over the next few years, and that should help boost the revenue and profits in the fund's underlying companies.

Specifically, according to consultancy firm International Data Corporation, consumer spending on technology is expected to hit almost $1.7 trillion this year, which represents an increase of 5.3% year-over-year. Furthermore, consumer spending is expected to remain strong across the board, with forecasts predicting consumer spending to reach $2.1 trillion in 2023, based on a five-year compound annual growth rate of 5.1%. While that is the sector average, some emerging technologies like drones are expecting to see growth rates well above that average figure, as shown below:

Source: International Data Corporation

My takeaway here is consumers are helping to support this sector, and the demand for these products appears to be accelerating, which is great news for investors. With consumer and business spending on technology, in the U.S. and around the globe, rising at robust levels, this is a sector investors will want to maintain exposure to for the foreseeable future.

Bottom-line

TDIV has had a strong 2019, and I expect similar results to continue going in to next year. While the fund has lagged the broader technology sector, I am content with recommending this fund because it offers exposure to some of the most established names in the space, which could be attractive for the more conservative, dividend-seeking investor. While higher growth potential can be found elsewhere, I prefer TDIV's dividend stream and below-average valuation. Couple this with strong performance in some of the fund's top holdings and robust consumer demand for technology products, I see TDIV as a profitable long-term play. Therefore, I maintain my "bullish" rating on TDIV, and would suggest investors take a serious look at the fund at this time.

This article was written by

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CEF/ETF income and arbitrage strategies, 8%+ portfolio yields

Macro-focused investor, working for a major U.S. bank. I grew up in New York, but escaped to North Carolina. I was a D1 athlete in college (men's tennis) and compete competitively to this day. My Bachelor's and MBA are both in Finance.

I provide reasoned, fact-based analysis of different funds and sectors. I list my portfolio here so readers can gain insight into what I am buying/holding, what I'm not, and how that lines up with the views I present in my articles. 

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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.

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