DVY ETF: Diversified Portfolio, Steady Yield, Lower Multiples (NASDAQ:DVY)

iShares Select Dividend ETF (NASDAQ:DVY) is a fully diversified large-cap exchange traded fund (ETF) launched by BlackRock, Inc. and is managed by BlackRock Fund Advisors. The fund has an asset under management (AUM) over $22.26 billion which it has invested in public equity shares of 99 companies listed in the US equity market. The fund was incepted on November 3, 2003, and has been paying regular quarterly dividends since its inception. DVY has recorded an extremely steady yield between three to four percent during the past 10 years, and its average yield comes to 3.3 percent during that period.

DVY has equally distributed its investment in basic/core industries (materials, utilities, energy, real estate and consumer staples), and investment in secondary & tertiary industries (information technology & communication, healthcare, consumer discretionary, financial, and industrial). Companies in the basic sector derive their revenue from very basic needs of people and industries (e.g. foods, house, gas, minerals and electricity). While these stocks are more steady, as these companies are less impacted by economic recession, companies in secondary and tertiary industries generate higher growth, but also are more volatile.

Around 51 percent of DVY’s portfolio is invested in 48 companies in basic industries, out of which almost 27 percent are in 28 utility companies. Remaining 49 percent is invested in another 51 companies out of which 22.5 percent is invested in 15 financial companies. As the operation of these companies are not integral to human existence, these stocks tend to be impacted more due to economic growth and downturn. Incidentally this fund has no investment in real estate firms. Each stock here occupies a very small proportion in DVY’s portfolio. Only two out of 99 stocks – Altria Group Inc. (MO), and Oneok Inc. (OKE) have more than 2 percent share in DVY’s entire portfolio of investments.

iShares Select Dividend ETF seeks to track the performance of the Dow Jones U.S. Select Dividend Index, by using representative sampling techniques. Dow Jones U.S. Select Dividend Index is composed of high dividend paying US equities. In representative sampling, some stocks of the benchmark index are selected in such a way that it reflects the characteristics of the index. To represent the benchmark index, the stocks are selected from every sector, every geographic location, and over all types of market capitalization.

Since its inception in November 2003, iShares Select Dividend ETF has been able to mimic its benchmark index and generate an annual average return of 8.8 percent, compared to 9.36 percent of its benchmark Index. Over the past 10 years, DVY’s market return was very healthy at 12.4 percent compared to 12.8 percent of its benchmark index. Over the past 5 years and 3 years, DVY has recorded an average market price growth of 10.6 percent and 15.4 percent respectively. During the same periods, the benchmark index had an annual average growth of 11 percent and 15.8 percent. The difference with the benchmark index is purely due to its expense ratio, which currently is 0.38 percent.

The past five years have been extremely volatile for the iShares Select Dividend ETF. While it grew by 15 percent, 22.5 percent and 32 percent in 2017, 2019, and 2021 respectively; DVY’s price dropped by 6 percent in 2018, and by 4.5 percent in 2020. 2018, as we all know, was a very poor year for the US equity market due to higher tariff, interest rate hikes, and tax cuts. On the other hand, this Dow Jones Select Dividend Index based fund was badly impacted by the covid-19 pandemic.

The holdings of iShares Select Dividend ETF recorded an average P/E of 13 and a P/B ratio of 2. The price multiples suggest that this fund is slightly undervalued. Though this stock is trading very close to its 52 week high of $130, there is hardly any indication that the price will move downwards. All the longer term simple moving averages (SMA) are placed below the shorter term moving averages. As on 8th April 2022, 200 day SMA (120.46), 100 day SMA (123.4), 100 day SMA (125.43), and 10 day SMA (128.55) are exactly in sync, so expect a steady bull run. Considering the strong fundamentals, I am a little surprised by the current level of price multiples of this diversified ETF.

Extremely balanced diversification that includes both stable stocks as well as high growth stocks, steady dividend, strong and steady price growth in the longer term, and the current level of lower price multiples makes this ETF very attractive, especially for long term investments. The US economy had enough volatility during the past five years. Unemployment, higher tariff, interest rate hikes, tax cut, inflation, all played their role. On top of that COVID-related supply chain disruptions and worker shortages made the situation worse.

However, extremely balanced diversification has helped this fund recover from the downward movement in both 2018 and 2020. DVY’s dividends have always been higher than 3 percent over the past 10 years. I don’t find any reason why DVY will not be able to continue its historical growth, and generate a steady total return between 12 percent to 18 percent over a longer time horizon. As a growth seeking investor, I’d certainly like to keep iShares Select Dividend ETF on my portfolio of investments.

However, the Dow Jones U.S. Select Dividend Index, as well as this iShares Select Dividend ETF can’t neutralize or overcome the patches of poor growth period. During the past five years, the stock had risen and dropped in every alternate year. As the uncertainties over economic recovery and energy prices are looming high, and the fund is already trading close to its 52-week high, a downward movement due to unfavorable news or stock market scenario can’t be totally ruled out. In order to be on the safer side I’d like to hedge this ETF with calls and put options, preferably for a longer term, as I don’t expect any significant downward movement immediately.

At present options with farthest expiry date are available for January 20, 2023 within a strike price between $40 to $185. The vast range in exercise prices of options on an expiry date of over nine months, can also be considered as an indicator of investors’ expectations of huge price movement on either side. In order to safeguard my investments from an unlikely steep downfall, I would prefer to spend another $7 to buy a January 20 put option at a strike price of $125, so that my principal investment does not incur a loss beyond 9 percent.