Value stocks are known for their superior risk-adjusted performance relative to flashier growth stocks over longer periods.
Value investors such as Warren Buffett have compiled impressive track records by shunning glamour stocks and focusing on steady companies with easy-to-understand business models.
“While companies that consistently generate high profits command higher valuations than traditional value stocks, the market has also historically undervalued these companies,” wrote Morningstar analyst Alex Bryan in a commentary this week. “This anomaly is consistent with Warren Buffett and Charlie Munger’s philosophy that it is better to buy a great company at a fair price than a fair company at a great price.”
The analyst pointed to a trio of ETFs that focus on high-quality companies that also have high profitability in the sense of how productively they use investors’ capital and assets. He’s talking about return on invested capital and similar measures.
Vanguard Dividend Appreciation ETF (NYSEArca: VIG) is one example. The fund recently slashed its expense ratio by 3 basis points to 0.10%. [Vanguard Cuts Fees on Dividend Appreciation ETF]
“While it doesn’t directly screen for profitability, VIG targets firms that have increased their dividends in each of the past 10 years,” Bryan wrote.
“This approach yields a portfolio of quality companies with strong profitability. Over the past year, the fund’s holdings generated an average return on invested capital of 15.2%, while the corresponding figure for the S&P 500 Index was 12.8%,” he added. “Additionally, a larger portion of VIG’s portfolio is invested in companies with wide economic moats.”
VIG is the largest dividend ETF with assets of more than $16 billion. The fund has pulled in more than $2 billion of fresh investor cash so far this year.
Next page: Large-cap and high-quality ETFs
The Morningstar analyst also mentioned iShares Russell Top 200 Growth Index (NYSEArca: IWY), which “offers an even stronger quality tilt than VIG, but its holdings trade at richer valuations, which may partially offset the benefit.”
IWY holds assets of about $407 million and charges an expense ratio of 0.20%. The ETF’s tracking index selects from the largest 200 U.S. companies with higher price-to-book ratios and higher forecasted growth.
Finally, Bryan highlights PowerShares S&P 500 High Quality (NYSEArca: SPHQ) as an ETF that gives concentrated exposure to profitable companies.
“It invests in companies from the S&P 500 Index with above-average growth and stability of earnings and dividends over the most recent 10 years,” he said. “Firms that score well on these metrics also tend to enjoy better than average profitability. Over the past year, the fund’s holdings posted an average return on invested capital of 14.9%.”
SPHQ has an expense ratio of 0.29%
PowerShares S&P 500 High Quality
