It’s often said that some value stocks are actually value traps, meaning that those names are cheap for all the wrong reasons.
In other words, not all value stocks are shares of quality companies. Some are actually downright poor quality names, implying that the combination of value and quality is alluring if not elusive. The American Century STOXX U.S. Quality Value ETF (NYSEArca: VALQ) makes harnessing that combination easier.
VALQ follows the iSTOXX® American Century® USA Quality Value Index. That benchmark employs a unique methodology. Rather than relying on the prosaic value metrics of price-to-earnings and price-to-book, VALQ’s index arrives at a value score generated by earnings and cash flow yields. Emphasizing those traits helps VALQ construct a roster that’s arguably more quality-heavy than traditional value funds.
Quality also implies profitability, the value of which cannot be underestimated as the Federal Reserve moves toward boosting interest rates.
“As the Federal Reserve moves closer to raising interest rates, investors are repricing their bets on one of the riskiest corners of the market: shares of companies that don’t make money,” reports the Wall Street Journal. “Cash-burning technology firms, biotechnology companies without any approved drugs and startups that listed quickly via mergers with blank-check companies—some of which soared during the pandemic—have dropped sharply.”
VALQ is only modestly allocated to rate-sensitive sectors, such as real estate and utilities, which makes sense because those groups are chock-full of cost-intensive, indebted companies. Conversely, the fund devotes 40% of its weight to technology and healthcare stocks. Those sectors are home to scores of companies with pristine balance sheets and massive cash hoards, which are enviable traits against the backdrop of Fed tightening.
Benefits offered by VALQ don’t end there. The fund’s underlying index also employs a dividend score based on dividend yield, dividend growth, and companies’ abilities to sustain those payouts. Those are potentially advantageous traits for investors because although interest rates will rise, they’re still low by historical standards. Additionally, market observers expect that S&P 500 dividends will hit another record this year after the payouts surged in the final three months of 2021.
“Q4 2021 U.S. common dividend increases were $20.6 billion, down 7.5% from $22.2 billion in Q3 2021 and up 48.5% from $13.9 billion in Q4 2020,” says S&P Dow Jones Indices. “Net indicated dividend rate change increased $18.0 billion, compared to $20.9 billion in Q3 2021, and $9.5 billion in Q4 2020.”
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.