S&P MidCap 400 Dividend Aristocrats ETF REGL July Update: Industrial Stocks Continue To Cruise

Summary

• Starting this month, I'll be providing regular updates on the S&P 400 MidCap Dividend Aristocrats.
• Investors should consider this exclusive group of 55 stocks, as they've done a better job outperforming their benchmark than the large-caps.
• The 15 years of consecutive dividend increases is more lenient, but my research shows that too strict criteria can hurt one's portfolio rather than help it.
• This review highlights metrics such as years of consecutive dividend growth, forward yields, dividend growth rates, payout ratios, cash flow, total debt, and more.

Lemon_tm/iStock via Getty Images

Overview

Most of you are already familiar with the S&P 500 Dividend Aristocrats (NOBL) - an exclusive group of large-cap U.S. equities that have raised dividends for a minimum of 25 consecutive years. But the S&P MidCap 400 Dividend Aristocrats (BATS:REGL) are great for widening your dividend growth selection pool as lately, opportunities are growing thin. With a more lenient requirement of 15 consecutive years of dividend growth, this exclusive group has outperformed its benchmark in the last ten years and done so with much less risk. If you're looking for cap size diversification, start here.

For those not familiar with the monthly reporting format I use for the large-caps, I summarize and evaluate the Aristocrats in four sections, as follows:

1. An overview of the 55 Dividend Aristocrats, including the selection process, historical performance, and summary statistics like forward yields and dividend growth rates.
2. A performance table showing one-month, three-month, six-month, one-year, two-year, and three-year returns for each constituent compared to the S&P 400 and sector peers.
3. A distribution analysis comparing forward yields to each company's minimum, maximum, and average yields over the last five years. A yield distribution metric alerts investors to when a company's yield is favorable.
4. A financial health analysis of each Aristocrat which includes their cash to total debt ratio, payout ratio, free cash flow margin, and revenue growth rates.

ProShares is the fund provider and charges 0.35% in annual fees. They currently manage just over $1 billion in assets, and note the following:

Source: ProShares S&P 400 Dividend Aristocrats ETF Overview

Constituents are reviewed once annually in January, with the last business day of December being the reference date. They are also rebalanced and re-weighted to an equal weight quarterly, effective the last business day of January, April, July, and October. Therefore, effective this week, it's back to an equal weight Index.

Sector Allocations and Top Holdings

The chart below shows how different REGL's composition is versus the iShares Core S&P Mid-Cap ETF (IJH). Like their large-cap cousins, you'll find a lot of Industrials and Consumer Staples stocks here. Notably, Technology is absent.

Source: Created By Author Using Data From ProShares and iShares

The top ten holdings are listed below.

Source: ProShares

Historical Performance

The performance history of REGL is limited. Nonetheless, it's managed to slightly outperform its benchmark despite higher fees (0.35% vs. 0.05%). More importantly, however, it's had much less risk. In particular, the Sortino Ratio, which is a standard measure of downside risk-adjusted returns, was substantially better. In my view, the strategy has succeeded.

Source: Portfolio Visualizer

We can learn a little more by evaluating the underlying indexes' performance, which includes some backtested data. The numbers are even better, with the mid-cap Aristocrats outperforming the S&P 400 by 0.65% per year.

Source: S&P Dow Jones Indices

It's worth noting that while the large-caps have produced superior returns, they've underperformed their benchmark. I think it's essential for investors to diversify in many ways, including by sector, region, and cap size. If you agree, the chart above is reason enough to consider REGL.

Current Statistics

There are currently 55 constituents in the Index, sorted below by sector, alongside some high-level statistics.

Source: Created By Author Using Data From Seeking Alpha And iOCharts

As expected with a defensive dividend ETF, investors are getting a fund that's typically less volatile than the market, as indicated by its five-year beta of 0.94. The average company has increased dividends for 29 consecutive years at an annualized rate of 6.80% in the last five years. The average yield is 2.35%, which is about 1.30% higher than IJH's. These statistics are very similar to the large caps, albeit with slightly less favorable dividend statistics.

Some stocks are paying excellent yields and have a terrific dividend growth history. Take UGI (UGI), for example. This natural gas distributor has increased dividends for 33 consecutive years at a rate of 7.80% over the last five years and currently yields 3%. These are the types of opportunities that open up by sliding just a little bit down the market cap scale.

Periodic Performances & Attribution

The table below shows the total returns of each Aristocrat on a one-month, three-month, six-month, one-year, two-year, and three-year basis.

Source: Created By Author Using Data From Portfolio Visualizer

The average mid-cap Aristocrat gained 0.25% in July compared to a gain of 0.36% for the S&P 400. There were a few different moving parts, though, which I've summarized below.

1. Like their large-cap cousins, the mid-cap Industrials had an outstanding month. The average stock gained 4.13% compared to just 1.17% for the S&P MidCap 400 Industrials Index. This outperformance contributed to an excess return of 0.87%.

2. Unfortunately, poor performance and sector allocation differences in the Health Care sector knocked off 0.51% in total return. Healthcare Services Group (HCSG) fell 17.33% on the month as the bears staked their claim, capitalizing on poor quarterly results. It also didn't help that the S&P MidCap 400 Health Care Index gained 1.94%, and HCSG is the Aristocrats' only representation.

3. Two other composition differences explained the remainder. First, the S&P MidCap 400 Consumer Staples Index lost 4.28%, and REGL is overweight this sector by 5.75%. And second, the S&P MidCap 400 Real Estate Index gained 4.10%, but REGL is underweight this sector by 6.52%. These differences accounted for another loss of 0.51%.

Yield Distributions

Value investors look to buy quality companies at attractive prices. On the assumption that Dividend Aristocrat status is synonymous with quality, I suggest tracking yield as a way of determining a good entry point. For example, buying a stock when its yield is significantly higher than it's been in the past suggests prices are depressed buy dividends have, nonetheless, continued. In my view, this strategy works best with consistent dividend payers like the Aristocrats.

The table below shows the forward yields of each Aristocrat alongside their minimum, maximum, and average yields over the last five years. The Yield Distribution column is the key metric here, and the higher the number, the more discounted shares are. For example, Southwest Gas Holdings' (SWX) 3.40% forward yield is currently higher than it's been 82.30% of the time in the previous five years. This is the product of its recent poor performance (-2.34% over the last three years) and its 4.76% dividend CAGR over the same time.

Source: Created By Author Using Data From iOCharts

In my article on NOBL, I noted that only 18/65 Aristocrats had yield distributions greater than 50%, suggesting that opportunities are dwindling. For REGL, 21/55 meet this criterion. While still low, the ratio is better, and I think that's one more reason to consider these mid-cap Aristocrats.

Financial Health

With that said, price is not the same as value, as often, there are good reasons for why a stock's yield is so high. Investors should still examine a company's financial health. I like to see sustainable payout ratios, manageable debt levels, and consistent sales growth that will support earnings growth and, in turn, dividend growth.

Source: Created By Author Using Data From Seeking Alpha

In my assessment, the financial health of the mid-caps is similar to the large-caps. For the latter, I found ten stocks meeting the following criteria:

• Cash to total debt ratio greater than 50%
• Payout ratio less than 65%
• Positive free cash flow margins
• Forward and five-year revenue growth rates greater than 5%

I don't think this is too much to ask for, but just eight stocks in REGL meet these criteria: Polaris (PII), Williams-Sonoma (WSM), FactSet Research Systems (FDS), RenaissanceRe Holdings (RNR), SEI Investments (SEIC), Graco (GGG), Toro (TTC), and Royal Gold (RGLD). Of these, RNR looks attractive to me. It has 20%+ revenue growth rates, a 30% free cash flow margin, a high cash to total debt ratio, and an ultra-low payout ratio. For the risk-averse investor, its low beta of 0.77 will be an attractive feature. It's an insurance play that should fare better in a rising rate environment. Still, the pandemic has seriously impacted their business, and the current low rate environment continues to pressure their investment yields.

Wrap-Up

The mid-cap Dividend Aristocrats nearly matched the S&P 400 in July, but the performance of Healthcare Services Group was the main reason for the slight miss. Otherwise, I found that they soundly beat their sector peers. If sector allocations were the same, REGL would have returned an additional 1.20%. Like with the large-caps, high-growth, consistent dividend-payers in the Industrials sectors are being rewarded. The 11 stocks in the ETF have an average five-year dividend growth rate of 9.69% compared to the fund's 6.80% average.

Historically, the mid-cap Dividend Aristocrats have outperformed the S&P 400 with both higher returns and lower risk. And with fewer opportunities appearing in the S&P 500, investors can go down a few billion dollars in cap size and add 55 more stocks to their watchlist. I hope you're able to use these tables to find your next opportunity, and if you're looking for a similar analysis on the large caps, be sure to check out my July update here.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SPY, IVV, VOO either through stock ownership, options, or other derivatives. 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.

Comments

[Carefree]

The first chart in your article shows NOBL/IVV, not REGL/IJH. Didn't bother to read the rest of the article after finding that error.

[The Sunday Investor]

@Carefree Thanks for the observation. I have submitted the correction, and I hope you can recognize that errors do happen from time to time. The incorrect title stemmed from my monthly NOBL articles, and the update just didn't take for some reason.

My apologies, but I think it's a little shortsighted to discount the entire analysis which takes a lot of effort to summarize. Nevertheless, I hope you find success elsewhere. All the best.