Get An Edge: Look At European Small Caps

Get An Edge: Look At European Small Caps

Get An Edge: Look At European Small Caps by Christopher Gannatti, Associate Director of Research, The WisdomTree Blog

It’s difficult to find an edge when investing. In many cases, it comes down to a single characteristic that has the potential to mitigate an important risk.

To that end, we offer up European small caps. The edge we see? Their dividend yields.

How Does Dividend Yield Connect to Total Return?

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While a higher starting dividend yield can never guarantee a higher total return, it can start things off with a push in the right direction, because:

Total Return = Dividend Growth + Return from Dividend Valuation Changes + Average Dividend Reinvestment Rate

  • Return from Dividend Valuation Changes: This component of the total return would be positive if price levels were to increase at a faster rate than dividend levels—in other words, if the price-to-dividend ratio rose or dividend yield compressed and became lower. The higher starting dividend yield provides cushion and less risk of valuations compressing and detracting from returns.
  • Average Dividend Reinvestment Rate: This component of the total return is similar to the average dividend yield over the period—so a higher starting value provides the potential for a higher overall average.

It is in these ways that we believe a higher starting dividend yield can give an edge in total returns when compared to a lower dividend yield option.

The WisdomTree Europe Hedged SmallCap Equity Index Delivers the Yield Edge

More than three-quarters of euro area small-cap stocks were dividend payers as of March 31, 2015, as compared to only 60% in the U.S1. The WisdomTree Europe Hedged SmallCap Equity Index focuses on this rich hunting ground of euro area small-cap dividend payers, and through its methodology delivers a higher dividend yield than U.S. small caps.

A Higher Dividend Yield Can Come from Weighting by Dividends

For definitions of indexes and terms in the chart, please visit our glossary.

  • More than 2x the Dividend Yield: The WisdomTree Europe Hedged SmallCap Equity Index has a dividend yield that was more than twice that of U.S. small caps. As mentioned earlier, this can signal an important potential edge in terms of total return.
  • Almost 75% Weight in Stocks with Dividend Yields above 2%: It’s interesting to see how this dividend yield is achieved—clearly weighting by dividends tilts weight toward stocks with higher yields.

1Source: Bloomberg.

Important Risks Related to this Article

Dividends are not guaranteed, and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

Investments focused in Europe are increasing the impact of events and developments associated with the region, which can adversely affect performance.

Investments focusing on certain sectors and/or smaller companies increase their vulnerability to any single economic or regulatory development.

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