WisdomTree US SmallCap Quality Dividend Growth Fund (NASDAQ: DGRS) aims to track growth and the results of small-cap companies that pay quality dividends. Characteristics of the US stock market.
What type of investor is DGRS suitable for?
If exposure to small caps is desired, the DGRS may be able to reduce the risk of buying junk.
- Most small cap investors want to see small stocks grow into very large stocks. Growth factors may help with that.
- Dividends can lead to basically sound stocks. Small companies that rely on stock dilution for growth are unlikely to pay dividends.
- Finally, the quality factor may segregate groups of stocks whose returns are reliable… stocks that are not. exploited or manipulated. High-quality earnings in small-cap stocks can potentially mitigate the risk of unreliable earnings.
It all sounds so good. Let’s open the hood and see how this fund is designed.
Are you a small cap fund?
First, I would like to determine if this is actually a small cap fund. My most common definition is that the market cap of a small cap he is between $300 million and $2 billion.
Here’s the problem. Fund managers want to pile up assets because more money in the fund means more total fees. But small-cap stocks can’t put in a lot of money in a day. What solution do most funds take? Expand the definition of small caps to include large caps.
To analyze DGRS, we first downloaded a list of all holdings from the DGRS website. Next, we looked at the market capitalization of each holding. The holdings spreadsheet also has a weighting for each position. Here is what i found.
- Top 57 stocks make up 50% of the fund
- The remaining 230+ stocks make up the remaining 50% of the fund.
- Average market capitalization of the top 57 stocks is $2.5 billion
The website ETF.com states that the fund has a weighted average market capitalization of $2.51 billion.
Please note that this is an average. There are large stocks and small stocks. For small-cap funds, he wants to average $1 billion or he wants to $1.5 billion. I consider this a very small mid-cap fund. If you’re investing in this for the size factor alone, there are better options.
Quality or Efficiency?
WisdomTree uses the term “quality” a lot. But what exactly is quality? how do they define it?
- They define quality as profitability.
To be fair, the quality factor is one of the more ambiguous. Not as clearly defined as value, momentum, sentiment, or growth. There may be a crossover between profitability and quality, but I wouldn’t call them the same thing.
Profitability is an efficiency ratio. It shows how much money is generated from a fixed amount of assets. All things being equal, you need an efficient company that can make a lot of profit without an intensive capital investment. But this also allows you to find service-based companies that don’t require large amounts of assets.
However, the term quality is usually Earnings qualityHere are some examples of why the quality of your earnings matters.
you have two companies. They have the same market cap. they have the same income. they have the same benefits. Companies look equal. But are the incomes really the same? necessarily.
- Compare the amount of incoming cash with the profit reserved. Are most of your gains in the form of accruals rather than actual cash flow?
- Are revenues based on normal operations or are one-off events driving revenues?
- Is the company heavily indebted and profiting from leverage?
Quality should tell you how much you trust your bottom line and whether you think it’s being manipulated to look better than it actually is.
There is a crossover between profitability and quality, but I feel they are not the same thing. The DGRS prospectus defines quality as return on equity and return on assets.
I feel this lacks the quality factor.
DGRS finds growth stocks by looking at long-term earnings growth expectations. This is not a problem as we actually screen stocks with high growth potential. I pass this element.
In other words, however, investors are advised to be wary of investing in growth stocks without considering value. Here’s why…
Analysts are known to be overly optimistic about future growth prospects. Much has been written on the subject, but he has only one paper discussing analyst optimism. Companies that are more difficult to predict are often met with optimism from analysts. What this means is that companies with very high future growth prospects are more likely to miss the mark.
Now, if the average investor had factored this in, this wouldn’t be a problem. Perhaps the growth rate he expects will be 30%, but investors will find it closer to 15% or 20% at most. Stock prices therefore reflect a more reasonable forecast. However, when unrealistic expectations are already built into the price, usually the price underperforms when high profit expectations are not realized.
There are ratios such as PEG (price to profit divided by growth rate) that try to combine purchase growth at a fair price. The idea is that the growth rate and the PE ratio should be about the same or less for rational buying. 30% future growth at 30 PE is an example.
Again, I don’t blame the fund for how it uses growth factors. However, I personally believe that investing in growth should be done from a value standpoint, so I only mentioned this as a warning to investors. Even if you are right, high growth can be a bad investment if the current price is not right.
It is in the fund’s best interest to keep the volume as low as possible. This reduces costs for the final investor. High turnover in small-cap stocks leads to high slippage and poor performance. DGRS rebalances and reconfigures he once a year.
All because I keep costs down. You definitely don’t want to over-trade small stocks, especially if you have a lot of AUM. But I don’t think annual rebalancing is the most efficient method.
The problem with annual rebalancing is that it’s not timely and doesn’t keep up with change. What if an analyst cuts her price/earnings outlook one month after her rebalancing date?I’ll hold for her next 11 months, even if I’m not in the fund. It also introduces timing risk. What makes certain dates better than others? If you’re unlucky, you could rebalance at the wrong time.
A better approach is to have more frequent rebalance or reconfiguration points. To keep sales down, you also need to add a buffer. For example, a potential he invests in the 100 fastest growing stocks out of 1,000 stocks. We check our holdings every month and replace stocks only if they fall below the 200th place. It was therefore added to the ranking buffer. This allows shares to be exchanged if they no longer fit the definition of a proper holding, but also keeps trading volume down.
Performance-wise, there is little difference between this and the Russell 2000 index. With DGRS, the dividend yield is slightly higher. But in terms of real performance from the start, they are so similar to me that I doubt the advantage of his DGRS diversification over IWM. With IWM’s low expense ratio of 0.19% versus 0.38%, it’s hard to see what other benefits DGRS offers.
My main concern with DGRS is that I don’t see any additional benefit from being designed at a lower cost than a simple cap-weighted Russell 2000 ETF.
- In my opinion, the DGRS is too big to be a true small-cap allocation.
- My preference is to focus on dividends or growth, but not both. Fast-growing companies should not pay dividends. And companies paying dividends probably aren’t at the top of their growth cycles.
- I wonder what they call the quality factor because the quality factor looks like an efficiency factor.
- I prefer to invest in growth combined with some kind of value.
- Finally, I don’t think annual rebalancing is too frequent. There are ways to increase responsiveness and timeliness without increasing turnover.
For me DGRS is the path. Dividend stocks may have a small advantage in that respect. Might be so Must be a small value slope.this May Provides a little downside protection in bad markets. Maybe. Dividend companies have outperformed lately. But I don’t see the merits to recommend it over the wider Russell 2000 fund.