Sage Investment Club

Torsten Asmus The WisdomTree Emerging Markets High Dividend ETF (NYSEARCA:NYSEARCA:DEM) remains extremely cheap and offers a high dividend yield reflecting the undervalued nature of the index. The ETF has outperformed the EM benchmark impressively over the past two years and should continue to do, largely due to dividend income. The DEM is one of the few indices globally that I track globally that is priced to deliver double-digit long-term real returns. DEM ETF Price And Total Return (Bloomberg) The DEM ETF The DEM tracks the performance of the WisdomTree Emerging Markets High Dividend Total Return Index, screening for the highest dividend-yielding stocks within the emerging markets. Included in its selection universe are dividend-paying companies over the prior annual cycle that meet minimum liquidity and size requirements. DEM selects the top 30% of firms ranked by dividend yield from the WisdomTree Emerging Markets Dividend Index. In addition, approximately 100 Chinese domestic listed companies by highest dividend yield that meet the index eligibility criteria will be selected for inclusion. Selected securities are then weighted based on dividends paid over the preceding annual cycle. Like most high dividend emerging market indices, the fund has a high weighting of commodity stocks, with materials and energy making up a combined 38% of the index. This is in part due to the Brazilian dividend giants Vale and Petrobras. Financials make up another 26%, reflecting the presence of the high dividend paying Chinese banks. The fund is well diversified in terms of single stocks, with the largest company Vale representing 7% of the index, and the top 10 stocks making up less than 30%. Unlike most EM focused ETFs, China does not have the highest weighting by country, with just 25% versus 28% for Taiwan. Brazil comes in third with a 13% weighting, although the extremely high dividend yields on offer in Brazil means that Brazilian stocks actually account for around one third of total dividends paid on the index over the past 12 months. The ETF pays a dividend yield of 7.9% and charges an expense fee of 0.63%. High Dividend Reflects Low Valuations As a general rule, high dividend yielding stocks are preferable to low dividend yielding stocks only if the high dividend yielding stocks reflect cheap valuations rather than elevated payout ratios. It is important therefore to understand whether the high yield on the DEM represents undervaluation or is merely a selection of companies that are paying out an excessive share of their earnings on dividends at the expense of future growth. With a trailing dividend yield of 9.6% and a trailing PE ratio of 5.0x, the dividend payout ratio is below 50%, compared to 37% for the MSCI Emerging Markets index. While the dividend payouts are high relative to the EM benchmark, the main reason for the high yield is the low PE ratio, which is roughly half of the level of the EM benchmark. DEM Trailing PE Vs MSCI EM Trailing PE (Bloomberg) These trailing valuations reflect record profit margins, and analysts expect to see a sharp decline in earnings and dividends over the next 12 months, particularly in Taiwanese and Chinese stocks. Even so, the forward PE ratio is still historically low at 6.2x and the forward dividend yield still high at 8.1%. The yield is still significantly above its 10-year average of 6.3% and 2.7x higher than the EM benchmark. Real Returns Expectations Are Far Higher Than The Broader Market Over the past decade the DEM has seen its dividends grow by 5.1% annually, broadly in line with sales and earnings. If we extrapolate this forward and add to it the forward dividend yield of 8.1%, this gives an expected long-term nominal return of 13.2%. With long-term market implied inflation expectations sitting just above 2%, even taking into account the weaker long-term growth outlook, real returns are still likely to be around 10%, which is significantly higher than the broader market. This view is closely in line with the 7-year real return forecast for Emerging Market value stocks published by GMO as shown below. 7-Year Annualized Real Return Estimates (GMO) High Yield Reflects Abundance Of Cheap Stocks One of the concerns I tend to have with high dividend indices is that they can often comprise of companies with extremely high dividend payout ratios rather than companies that are fundamentally cheap. This is emphatically not the case for the DEM. If we look at the underlying WisdomTree Emerging Markets High Dividend, it currently trades with a P/E ratio of just 5.9x, which is on par with the Covid crash lows. With the underlying index paying a dividend yield of 8.9%, this equates to a payout ratio of just over 50%, which is by no means excessive. Iron ore giant Vale (VALE), which currently pays a staggering 16% dividend yield, dominates the index with an 11% weighting. Apart from Vale, no other single stock has a weighting above 4%, and there are 483 companies in the index, significantly higher than most other EM ETFs. While the expense ratio is substantial at 0.63%, this pales in comparison to the fund’s dividend yield, which is currently an impressive 6.3%.

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