Exchange Traded Funds with a Dividend Focus

Exchange traded funds (ETFs) are funds that trade like individual stocks. The investment objective of ETFs is to replicate the performance of a particular index. The index upon which an ETF is based can represent a common market index like the S&P 500 Index, a small company stock index like the Russell 2000 index, or the index can represent a segment of the market. For example, ETFs are available to investors that represent specific sectors of the stock market, for example, the financial sector within the S&P 500 index or the financial sector of the Dow Jones Industrial Average.

ETFs with wide ranging investment objectives have been created, in part, due to the popularity of indexing. This popularity has lead to the creation of ETFs with the underlying index based on dividend paying stocks. One drawback of indexing is the performance of the ETF will be in line with the performance of the index in declining markets. In 2000-2002 , investors would have experienced significant declines in the market value of an ETF that replicated the performance of the S&P 500 index during the technology bubble correction. On the other hand, ETFs do trade like stocks so an astute investor could have quickly sold the S&P 500 ETF to minimize potential losses. Often times though, the decision to sell is not evident until one looks back with 20/20 hindsight.

Some of the dividend focused ETFs are:

• First Trust Morningstar Dividend Leaders Index Fund (ticker FDL)
• iShares Dow Jones Select Dividend Index (ticker DVY)
• SPDR Dividend ETF (ticker SDY)
• Vanguard Dividend Appreciation ETF (ticker VIG)
• PowerShares High Yield Equity Dividend Achievers Portfolio (ticker PEY)
• PowerShares Dividend Achievers Portfolio (ticker PFM)
• PowerShares High Growth Rate Dividend Achievers Portfolio (ticker PHJ)
• PowerShares International Dividend Achievers Portfolio (ticker PID)

When evaluating ETFs having a narrow investment focus, like those listed above, an investor needs to thoroughly research the composition of the ETF. For example, in the PowerShares High Yield Equity Achievers Portfolio, the financial sector represents over 49% of the investments as of 8/31/2006. In addition to sector concentration, one needs to review the number of stocks within the ETF as well evaluate the percent of the assets invested in the larger holding(s) of the ETF. In the case of the First Trust Morningstar Dividend Leaders Index Fund, Citigroup is over 9% of the investments as of 8/31/2006. Also, over 65% of the Morningstar Dividend Leaders ETF is invested in the top 10 holdings of the ETF as of 8/31/2006.

In conclusion, there are a number of other issues one must evaluate before investing in ETFs: taxes, expense ratio, yield, etc. A positve aspect of ETF type investments is an investor can obtain exposure to certain areas of the market in a quick manner. Keep in mind though, there aren't any famous market timers.

Sell in May and Buy in November?

The S&P 500 Index performed well during the 3rd quarter of 2006 by returning 5.6%. Historically, strong performance has not been a characteristic of the 3rd quarter of a mid-term election year. A review of this phenomenon is contained in the Businessweek Online link.

(click on graphs for larger image)

Does a strong 3rd quarter indicate the 4th quarter will be a weak one? Not necessarily. The old adage "sell in May and go away" is an old Wall Street mantra that has worked at times in the past. The market does have a tendency to exhibit weaker performance characteristics from May-October; however, one must look at where the Fed and the economy are within their cycles. The Fed appears to be on hold if not done raising interest rates.

In a BusinessWeek article dated May 4, 2005 titled, Sell in May, But Don't Walk Away, Sam Stovall details the potential market opportunity for the period November through April.

September Performance of Dividend Payers versus Non Payers

Following is an update on the performance of dividend paying versus non-dividend paying stocks in the S&P 500 Index. This information is compiled by Standard and Poors.

Total Return Performance as of 9/29/2006:
	Average	Average	S&P 500	Weighted
	S&P 500	S&P 500	Weighted	Total
	Payers	Non-payers	Change	Return
Month-average change	2.56%	2.76%	2.46%	2.58%
YTD	9.18%	5.84%	7.01%	8.53%
12-months	12.69%	6.83%	8.71%	10.79%
# of Stocks	384	116	500	500
Average yield	1.94%		1.86%

Dividends as an Approach to Selecting Stock Investments

One method to use in selecting equity investments is to focus on a company's dividend practice. With dividend growth stocks, a company's board of directors (BOD) know its investors tend to own the stock in part to collect an ever growing dividend or income stream. A company's BOD will strive to maintain the dividend growth rate even when business may be weakening. This desire to maintain the dividend growth will force other company financial measures to deviate from normal levels when business may be weakening. Over time, a company's long run stock return tends to match its long term dividend growth rate, all else being equal.

Ideally, one would want to invest in a company that increases its dividend at least every fifth quarter. Additionally, the dividend yield should be at such a level, say greater than 1%, that any change in the dividend growth rate is significant enough to have an impact on a company's balance sheet and cash flow.

An example would be Aflac (ticker AFL). The company reported earnings on 10/24/2006 that were lower than the same quarter a year earlier. However, if one looks at AFL's 3rd quarter 2006 operating earnings, they were up 9.1% compared to the 3rd quarter of 2005. One reason cited for the lower earnings was the impact of a stronger US Dollar versus the Yen. Nearly 75% of AFL's revenue and earnings are generated from the company's Japanese business segment. Looking forward, the markets project the US Dollar will weaken against the Yen (Yen Chart). A weaker US Dollar will enhance AFL's earnings as the Yen is converted to US Dollars for financial reporting purposes. From a dividend perspective, AFL increased its 4th quarter dividend to 16 cents a share versus 11 cents a share in the same quarter a year earlier. The company also stated they were increasing the 1st quarter 2007 dividend to 18.5 cents per share versus 13 cents a share in the 1st quarter of 2006. Is this an indication that the company anticipates improving business going forward?

AFL	Dividends per Share ($)
	2002	2003	2004	2005	2006	2007
March	0.05	0.07	0.095	0.11	0.13	0.185
June	0.06	0.07	0.095	0.11	0.13
Sept.	0.06	0.08	0.095	0.11	0.13
Dec.	0.06	0.08	0.095	0.11	0.16

AFL	Dividends per Share YOY Comparison
	2002	2003	2004	2005	2006	2007
March	18%	40%	36%	16%	18%	42%
June	20%	17%	36%	16%	18%
Sept.	20%	33%	19%	16%	18%
Dec.	20%	33%	19%	16%	45%

The 5-Year dividend growth rate for AFL is 22%. An item to watch is the payout ratio. The company's payout ratio has increased from 15% in 2002 to 19% in 2006. Annualizing the 18.5 cent 1st quarter dividend results in a 2007 projected payout ratio of 22% for the year 2007.

From a stock price perspective, based on Friday's closing price of $45.08, the stock is trading approximately 9% below its 52-week high of $49.65 and approximately 6% above its 52-week low of $42.41.

My initial post

For some time I have contemplated creating this blog. I will strive to post relevant investment information on a daily basis. The goal of the site is to provide investors with insight into an investing approach that will create wealth over time. An important aspect of wealth creation is not losing ones wealth when the markets are not moving higher.

My personal investment bias is to invest in companies that generate a steady return over time, i.e., singles and doubles. This singles and doubles approach tends to lead to investments in higher quality dividend growth companies. On the other hand, there are times when a company's stock price seems to be trading below its fair valuation. Short term gains are possible in these situations.