Investing in dividend aristocrats is a time-proof strategy for building a consistent income stream. But the issue is that the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) is underweight in tech stocks, which accounted for only 3.3% of the portfolio on April 1. What if an investor wants to steer clear of traditional cyclical sectors like industrials and materials that suffer most during recessions and build a dividend growth-oriented portfolio of IT stocks? There is a way to do so: the ProShares S&P Technology Dividend Aristocrats ETF (BATS:TDV), a fund that I would like to discuss today.
With TDV, investors can gain exposure to a combination of tech-like expansion prospects and consistent dividend growth stories that encompass at least seven years. The flip side is that TDV's standardized yield is almost half of NOBL's 2.25% and is even lower if compared to 1.46% of the iShares Core S&P 500 ETF (IVV). Hence, for yield hunters, TDV would be a suboptimal choice.
Another problem I see with the fund is that its underlying index's methodology is far less picky if compared to the S&P 500 Dividend Aristocrats index. Besides, with its expense ratio of 0.46%, TDV is more expensive than NOBL, which charges 0.35%.
The Underlying Index
TDV tracks the equally-weighted S&P Technology Dividend Aristocrats Index. To be eligible for inclusion, an IT stock must be a constituent of the S&P Total Market Index, the one that encompasses 3,624 equities at the moment, 482 of which are from the technology sector (as comes from the iShares Core S&P Total U.S. Stock Market ETF (ITOT) holdings).
And here comes the first essential difference between NOBL and TDV investors should pay attention to: the underlying index of NOBL can include only S&P 500 companies. This, in turn, implies that this fund invests only in large-cap players, while TDV's approach is rather mixed since it is long both mega-caps like Apple (AAPL) and small-cap names like Cass Information Systems (CASS). This approach can result in more volatile dividend income since small-cap players are less resilient.
Another principal difference is that though the index contains "dividend aristocrats" in its name, an investor should not expect to see only companies that have been increasing their annual payouts for at least 25 years. For the eligible tech stocks, S&P Dow Jones Indices significantly lowered the bar for the dividend growth period. To join the benchmark, a company could increase its payout for only seven years, or even for shorter periods in the case lower than 25 constituents meet the criteria. As it was explained on page 5 of the methodology, then the index provider will consider other names that have been increasing their payout for shorter periods (even lowering the bar radically to four years).
What was the rationale behind loosening the DPS growth requirements? I reckon to account for a fact that IT is a relatively young sector. When Exxon Mobil (XOM) had already been increasing its annual payout, Microsoft (MSFT) was not even a publicly-traded company. Another goal was likely to strip off the effect of the dot com bubble and the Great Recession. But in this sense, we cannot say that TDV holdings are all-weather dividend investments since most of them (well, at least MSFT easily weathered the late-2010s economic calamities) were not tested by the 2008-2009 crisis, while the dividend aristocrats have already weathered a few severe economic downswings, and most even hiked their payouts last year ignoring the pandemic (except for XOM, T, LEG, SYY, and CAT).
In sum, if compared to NOBL, most TDV holdings have only nascent dividend growth stories.
The Holdings Discussion
At the moment, the TDV portfolio is much smaller if compared to NOBL, as it has 38 holdings (excluding cash) vs. 65 in the case of its peer. Are there any NOBL members present in the TDV portfolio? Yes, but only two: ADP in 5th place and IBM in 23rd place.
I used the Wayback Machine to analyze how the fund's portfolio looked like last year, before the January 2021 reconstitution, for example, on November 28. The comparison of the two datasets shows that since then, the portfolio has been significantly recalibrated. The following names were removed from the portfolio:
- Xilinx (XLNX), a developer of programmable devices since Advanced Micro Devices (AMD) decided to acquire it.
- MKS Instruments (MKSI), a semiconductor equipment supplier. The last time it increased DPS was in 2018.
- FLIR Systems (FLIR), a thermal imaging systems developer, as its dividend growth story stalled.
- NVIDIA (NVDA), a visual computing heavyweight, by the same token.
These stocks were added:
- CDW Corporation (CDW), an integrated solutions provider with a yield of 0.94%.
- NetApp (NTAP), a cloud data services company. It is currently yielding 2.6%.
- Perspecta (PRSP). PRSP will likely be removed from the portfolio since in January, Peraton announced it would acquire the company.
- 2.2% yielding CSG Systems (CSGS), a revenue management & customer experience solutions provider.
- 2% yielding Avnet (AVT), a technology solutions company.
- 2.45% yielding National Instruments Corporation (NATI).
Here comes another difference between TDV and NOBL: the latter has a more stable portfolio, with only infrequent changes from year to year.
The Top-Ten Names
Though the fund is currently trading with an SEC 30-day yield of 1.27%, some of its holdings have valuation anomalies. Surprisingly, there are equities that have energy sector-like multiples, with HPE even trading at an even cheaper level than Exxon Mobil.
Here are TDV's top ten investments:
- Hewlett Packard Enterprise (HPE), with a 3.24% weight. The company might be considered a value play in the tech sector since it is trading at just 11.3x EV/EBIT (Forward) vs. 14.4x in the case of XOM.
- HP (HPQ) is another value play that is trading at a discount to the IT sector.
- CDW Corporation (CDW) cannot boast a sector-leading Value Grade, which is only C at the moment.
- 1.78% yielding Oracle (ORCL).
- 1.96% yielding Automatic Data Processing (ADP).
- Cass Information Systems (CASS), with a yield of 2.33%.
- 2.85% yielding Cisco Systems (CSCO).
- 2.18% yielding Corning (GLW).
- 2.61% yielding NetApp (NTAP).
- Finally, PetMed Express (PETS), with its generous yield of 3.29%.
The Total Returns Discussion
As the fund was established in November 2019, we have only limited data on returns to discuss. But the figures that we have already point to the fact that since inception, TDV has performed much stronger if compared to both SPY and NOBL. And as a reminder, this was achieved with only limited exposure to the FAANGM cohort.
And surprisingly, TDV even trounced both the U.S. market and the dividend aristocrats in the last six months, which contradicts the hypothesis that only cyclical, mostly value stocks were enjoying robust gains during that period thanks to the coronavirus vaccines that should secure quick economic recovery this year.
In conclusion, though TDV has delivered alpha since inception, it still has a few disadvantages if compared to NOBL, namely the following:
- Exposure to small-cap tech companies that are less resilient than large-cap players,
- the higher expense ratio,
- the much lower standardized yield of just 1.27%, hence, more expensive valuation overall,
- the portfolio of stocks mostly with only nascent DPS growth stories that were not tested by the Great Recession, and
- exposure to the industry consolidation risk: smaller players could be easily acquired by companies outside of the sector (like in the case of Perspecta) or by IT heavyweights and thus they will be removed from the TDV portfolio.