How This Mid-Cap Index Became Less Pricey Despite Strong Gains by Christopher Gannatti, Associate Director of Research, The WisdomTree Blog.
The S&P 500 Index has had a strong 16.2% average annual return for the past five years,1 making it a very difficult index to beat. However, it is worth noting that broad measures of U.S. mid-cap equities have actually performed even better over the same period2:
• WisdomTree MidCap Earnings Index3: 18.8% per year.
• S&P MidCap 400 Index4: 17.0% per year.
• Russell Midcap Index5: 17.7% per year.
Now, with such great performance comes the inevitable question: Are U.S. stocks becoming expensive?
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If Fundamentals Are Growing, Value Is Easier to Find
The typical way to answer this question is to cite price-to-earnings (P/E) ratios and examine the relationship between share price and earnings per share. However, there are many fundamental metrics that can be used to look at valuation. One that we focus on often is dividends.
Dividend Growth since the Global Financial Crisis Has Been Exceptional
At WisdomTree, we spend a lot of time looking at dividend trends around the world, and one of the first things we point out to people when talking about U.S. markets is that even though the performance has been strong, the dividend growth has been stronger. Putting the above-average share price performance into context, we can therefore tie it back to above-average dividend growth.
Dividend Growth and the Price-to-Dividend Ratio
The price-to-dividend ratio is no different than the price-to-earnings ratio—it simply looks at share price relative to dividends instead of looking at share price relative to earnings. In both ratios, if the underlying fundamental is increasing faster than the price levels, the ratio will become less expensive.
Bottom Line: Even with an 18.8% return over the past five years, the WisdomTree MidCap Earnings Index actually saw such strong dividend growth that the price-to-dividend ratio decreased at a rate of 2.5% per year over the same period.6
The Remarkable Dividend Growth Trend of U.S. Mid-Caps
• WT MidCap Earnings Index Growing Dividends at 20% per Year: This is the classic case of an index where the returns have been strong, but the dividend growth has been stronger. The result? The price-to-dividend ratio actually decreased over the past one-, three- and five-year periods.
• Mid-Cap Dividend Growth Outpaces S&P 500 Dividend Growth: Each of the mid-cap indexes shown had dividend growth faster than that of the S&P 500 Index over the past one-, three- and five-year periods. Large-cap and small-cap equities certainly get significant attention, but the strong levels of dividend growth are one reason we think mid-caps can also be exciting.
Follow the Fundamentals
The WisdomTree MidCap Earnings Index takes an approach that emphasizes following the fundamentals, as every constituent must prove its profitability at each annual Index screening. While the Index doesn’t require every constituent to be a dividend payer, the dividend growth that it has displayed over its performance history has been impressive.
1Source: Bloomberg, for five-year period ending 2/28/15.
2Source for all bullets: Bloomberg, for five-year period ending 2/28/15.
3WisdomTree MidCap Earnings Index standardized average annual returns as of 2/28/15: one-year return: 10.2%; three-year return: 18.4%; since-inception return: 10.5%. Inception date: 2/1/07.
4S&P MidCap 400 Index standardized average annual returns as of 2/28/15: one-year return: 11.1%; three-year return: 17.2%; since WT MidCap Earnings Index inception return: 9.2%.
5Russell Midcap Index standardized average annual returns as of 2/28/15: one-year return: 13.3%; three-year return: 18.9%; since WT MidCap Earnings Index inception return: 8.5%.
6Source: Bloomberg, for five-year period ending 2/28/15.