Not Your Classic Dividend ETF: RDVY Is An Outstanding Performer

Summary

• The NASDAQ US Rising Dividend Achievers Index has an outstanding track record of beating the S&P 500, but will likely underperform in the near term.
• The secret is a focus on cash preservation through a combination of a high cash to total debt ratio and a low payout ratio.
• Its higher fees and low yields may be disqualifiers for income investors, but total return investors will appreciate RDVY's simple recipe for success.

Photo by TAW4/iStock via Getty Images

Investment Thesis

The First Trust Rising Dividend Achievers ETF (NASDAQ:RDVY) is a tough sell for dividend investors. Its trailing dividend yield is a paltry 1.30%, its annual fees of 0.50% aren't very competitive, and it runs the risk of being too concentrated as it only holds 50 stocks. But to ignore this great ETF on those criteria alone would be a mistake. This article will take you through why RDVY is a terrific option for investors not needing regular dividend income. My analysis will be done both at the fundamental and technical levels and will include a discussion about the semiconductors industry, the fund's largest. After considering all this data, RDVY quickly moved up the list of my favorite dividend-themed ETFs on the market today.

Fund Basics

RDVY At A Glance

• Index: NASDAQ US Rising Dividend Achievers
• Inception: 01/06/2014
• Expense Ratio: 0.50%
• Number of Holdings: 50
• Dividend Yield (Trailing): 1.30% (Paid Quarterly)
• Consecutive Years of Dividend Growth: 4
• Dividend Growth Rate (5Y): 3.87%
• Total Net Assets (Billions): $3.872
• Average 30-Day Volume: 1,010,754

RDVY Methodology

RDVY tracks the NASDAQ US Rising Dividend Achievers Index, which includes companies that have paid more in dividends in the last year than in the previous three and five years. Companies must also have higher earnings per share than they did three years prior, have cash to debt ratios greater than 50%, and a trailing twelve-month payout ratio less than 65%. After excluding REITs, eligible companies are ranked, and the best 50 are included. The Index is reconstituted annually in March and is rebalanced quarterly to equal-weights in March, June, September, and December.

This methodology is unique as the dividend and earnings requirements aren't difficult to achieve, especially in bull markets. As a result, RDVY is more likely to result in a blended fund of growth and value stocks. Also, the cash to debt ratio and the trailing payout ratio requirements will tend to push yields down. Therefore, it may be appropriate to view RDVY as a broad-market alternative based on many of the tenets of dividend investing.

RDVY Sector & Industry Allocations

RDVY appears to be a very concentrated fund right now, likely remaining this way until the next reconstitution in March 2022. Information Technology and Financials make up about two-thirds of the fund, with Consumer Cyclicals and Industrials sharing a further 20%. Allocations to defensive sectors such as Health Care and Consumer Staples are negligible, and in addition to REITs, the Utilities sector is presently absent.

Source: Created By Author Using Data From First Trust

While there are only 50 holdings, RDVY includes investments in 30 industries. Therefore, I'm hesitant to jump to the conclusion that it isn't diversified. The chart below shows RDVY's constituents by its top 15 industries, which collectively make up 70.55% of the fund.

Source: Created By Author Using Data From First Trust

As shown, there is a reliance on the Semiconductor and Semiconductor Equipment and Materials industries, which make up 14.11% of the fund. Credit Services, Diversified Banks, Regional Banks, Capital Markets, and Life Insurance combine to make up most of the Financials sector, which has generally recovered well in the last couple of quarters.

RDVY Top Holdings

Due to its equal-weight methodology, the current top ten holdings won't reveal much other than the best performers over the last month. Nevertheless, First Trust updates these holdings daily and are shown below.

Source: First Trust

RDVY Has Outperformed The S&P 500

Actual Performance

RDVY has performed well since its inception, returning an annualized 15.42% since February 2014 and 19.74% YTD - both better than the S&P 500, though its risk-adjusted returns are worse. The Sharpe Ratio, which measures excess return per unit of risk, is only 0.85 for RDVY compared to 1.00 for SPY.

Source: Portfolio Visualizer

In the last decade, dividend ETFs have generally produced lower total returns but higher portfolio income. The opposite is true for RDVY, however. The following table shows the annual income generated (assuming dividends are reinvested) with an initial $10,000 investment.

Source: Portfolio Visualizer

Backtested Performance

Nasdaq provides backtested data on the Index that predates RDVY's launch, so this information will be beneficial for those looking to understand how the Rising Dividend Achievers performed through the Great Financial Crisis. The following graph compares the Index performance against the S&P 500 Total Return Index from April 2007 until September 2013.

Source: Created By Author Using Data from NASDAQ and Yahoo Finance

The above shows a total return of 64.21% for the Rising Dividend Achievers compared to 36.36% for the S&P 500. This represents a CAGR of 7.93% vs. 4.89%. While this does not take into account fees, investors would keep approximately 92% of the returns after adjusting for a 0.50% expense ratio over 6.5 years.

I highlight this because we now have nearly 15 years of data showing an excellent track record of outperforming the S&P 500. The reason, I believe, is its focus on cash preservation. Eligible companies must be successful enough to generate operating cash flow to cover at least half their total debt. These companies also balance making sustainable dividend payments while also ensuring enough cash is left to grow the business. Income investors may not like this strategy, but the success is undeniable for those focused on total return.

Fundamental & Technical Analysis

RDVY Dividends

RDVY is not an ETF likely to show up when screening for dividend yield. Its trailing yield of 1.30% isn't enough for those requiring a decent income, especially in retirement. However, for those who crave safety over yield and growth over income, RDVY certainly checks many boxes. The table below shows some key dividend statistics by industry. It is here where I would like to highlight the low payout ratios and high dividend growth rates for virtually all of the top industries.

Source: Created By Author Using Data From Seeking Alpha

First, the weighted average payout ratio is phenomenal - only 27.14%, which is even better than the four-year average of 32.68%. For example, the top holding in the Semiconductors industry, Nvidia (NVDA), has a payout ratio of just 4.72%. In the Credit Services industry, all four holdings have payout ratios less than 24%. While companies must have a payout ratio less than 65%, only eight are above 40%.

Second, the five-year annualized dividend growth rate is equally impressive at 15.45%. As a comparison, SCHD's growth rate is 13.28%, while DGRO's is 11.63%. In particular, there is dividend growth success in the Diversified Banks industry, where Citigroup (C) has grown its dividend at an annualized rate of 59.12% in the last five years. Bank of America (BAC) and JPMorgan Chase (JPM) have also done well, raising their dividends by 29.20% and 15.39%, respectively.

RDVY Momentum Analysis

To analyze the RDVY's momentum, I calculated some weighted-average statistics by industry to gauge whether we can expect a healthy pullback soon. The graph below shows each industry's performance against its 100-day moving average price as well as its annual price position, which is a standardized way of showing how close it is to trading at its 52-week high.

Source: Created By Author Using Data From Seeking Alpha

First, the annual price position, represented by the orange bars and the left vertical axis, shows that nearly all industries are trading at around 90% of their 52-week highs. The exception is the semiconductors industry, which is only 75%. I'm not entirely surprised at this statistic since we are about a year out from when the markets bottomed out last March, but it's enough to make one pause before taking out a position.

What's more telling is RDVY's weighted average price against its constituents' 200-day moving average. This figure, which nets out to be 11.64%, is significantly higher than the S&P 500's 7.53%. Since this is material and not in line with the historical performance of the two, I suggest RDVY will underperform the S&P 500 in the near term.

Risks To The Semiconductor Industry

The Semiconductors industry has risen the least in the last year because of a global chip shortage. This shortage, which is not expected to end soon, has been caused, in part, by businesses shifting to a remote workforce. As summarized by a recent article on MarketWatch:

Demand for chips powering laptops, gaming devices and internet infrastructure skyrocketed, while chip demand for auto and industrial uses plummeted. When the factories that make basic computer components couldn't make them fast enough, already-long customer waiting lists for those factories got even longer. With demand remaining high and little additional chip-making capacity expected in the short term, the shortage is expected to last into at least next year.

The following table shows the 1Y TTM revenue growth rates for each of RDVY's five constituents in this industry. Intel (INTC) is the clear loser in revenue growth and total returns, but the company is looking into producing chips for cars to address the shortage in the auto industry.

Source: Seeking Alpha

Though the industry has its challenges, company leadership is still optimistic. According to a KPMG survey, 85% of companies expect positive revenue growth over the next year, while 47% expect double-digit growth. In addition, 79% expect profitability to improve next year due to more strategic spending and increased demand.

Source: KPMG Global Semiconductor Industry Survey Findings

Investment Recommendation And Conclusion

RDVY has a terrific track record that dividend investors may overlook. Its yield is low, its fees are on the high end, but its returns are spectacular. I attribute most of this to the focus on cash preservation, which increases the odds that eligible companies can grow their businesses and dividends simultaneously. The earnings and dividend criteria aren't overly strict either, which is an advantage. Often, the best opportunities are in companies experiencing temporary downturns, and the Index does not exclude such companies because of one or two years of flat growth.

I believe RDVY will underperform the S&P 500 in the near term because of the recent price performance of its constituents. Nearly all are trading near their 52-week highs. But the underperformance will be temporary. For those not needing a high dividend income and are looking for an S&P 500 alternative for the long term, RDVY is a definite buy.

Analyst’s 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.