Expensive ETFs —
the P/E Under the Hood

Categories Investing, OSAM Research

“Trump Bump Boosts ‘Smart Beta’ Funds”   — WSJ, Feb. 5, 20171

The chart below helps answer these 2 questions: “Do I really want to rely on a tweet to drive my investing success?” and “Am I (and/or are my clients) in an ETF that selects its stocks for their scalability rather than their potential to generate alpha?”2 Additionally, this article asks “How does a contrarian thesis of ‘building resilient, inexpensive portfolios by selecting quality, high-yielding stocks’ — or something along those multi-thematic lines — look under the lens of P/E?”3

Following up on a prior ETFs-related blogpost (see Factors are Not Commodities), this new chart further illustrates how ETF investors may be missing out on some good bargains. By using a simplified measure of “cheapness” — the factor profile of various markets’ and portfolios’ P/E ratios — we’ll take a quick look at the aforementioned income-seeking strategy designed to build inexpensive portfolios that select quality, high-yielding stocks in a disciplined manner with high conviction4 in comparison to (A) a group of popular dividend ETFs,5 (B) MSCI’s fraternal indexes World6 & ACWI,7 and (C) some regions & individual countries. This is what you see in Bloomberg, alongside our own research from Compustat & Worldscope:

 P/E Ratios as of 12/31/16
chart The global, inexpensive portfolio that selects quality, high-yielding stocks
is priced at a P/E discount of:
(A) 37% vs. the group of popular dividend ETF portfolios and
(B) from 23% (World) to 20% (ACWI) vs. those MSCI indexes.
Plus, (C) broadening the universe of stocks beyond U.S./Europe/Japan
contributes additional discounted valuation opportunities.

This year could be bumpy enough as it is, and potential roadblocks can make overpriced stocks an even bigger risk than they already are. Bearing in mind some basic ABCs may help smooth the road ahead.

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  1. Loder, Asjylyn “Trump Bump Boosts ‘Smart Beta’ Funds [ETFs]” (2/5/17) http://www.wsj.com/articles/with-etfs-a-companys-size-doesnt-always-matter-1486296001
  2. See also: osamlibrary.com, April 6, 2016.
  3. Price-to-earnings (P/E) is the price of a share of a stock divided by earnings per share, usually calculated using the latest year’s earnings.
  4. See EnhancedDividend.com for an updated metrics dashboard showing the results by using a hybrid of multi-factor themes.
  5. Vanguard Dividend Achievers (VIG), iShares Select Dividend ETF (DVY), Vanguard High Dividend Yield Index Fund ETF (VYM), and SPDR S&P Dividend ETF (SDY)
  6. The MSCI World Index Net is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets. The index includes securities from 24 countries but excludes stocks from emerging and frontier economies making it less worldwide than the name suggests. This index is net of withholding taxes.
  7. The MSCI ACWI Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets. This index is net of withholding taxes.