Small-capitalization stock exchange traded funds that follow a dividend theme may have a greater value tilt, providing relatively cheaper valuations compared to the broader market.
For instance, the WisdomTree SmallCap Dividend Fund (NYSEArca: DES) offers a strong value tilt, according to Morningstar analyst Alex Bryan.
DES tracks the WisdomTree SmallCap Dividend Index, which is comprised of small-capitalization stocks weighted by cash dividends each component company is projected to pay in the coming year. The ETF comes with a 2.68% 12-month yield.
“This introduces a value tilt in two ways,” Bryan said. “First, dividend-paying stocks tend to be slower growing and trade out lower valuations than non-dividend-paying firms. Secondly, the fund’s dividend-weighting approach causes it to increase its exposure to stocks as they become cheaper relative to their dividends and trim back on positions that become more expensive when it rebalances.”
Specifically, DES shows a 17.6 price-to-earnings ratio and a 1.7 price-to-book. In contrast, the iShares Russell 2000 ETF (NYSEArca: IWM) has a 19.4 P/E and a 2.0 P/B. The value tilt would arguably allow investors to profit off mean reversion in valuations.
Moreover, since small-caps are typically less closely monitored than their large-cap counterparts, there is a greater chance for smaller stocks to become mispriced or at least less efficiently priced than larger companies, which can help value-oriented investors, Bryan argued.
DES also provides a little more stability as it tracks companies with steady dividend payments. Companies with large cash stock piles and low dividend payouts may purse riskier projects. The steady dividend yields may also indicate a company’s confidence in its future outlook, especially when they raise yields. In contrast, investors typically have an unfavorable view on companies that cut dividends.