“Smart beta” ETFs are all the rage these days, and those with a taste for such next-generation index investing can go beyond cap-weighted indexes and look for funds that screen securities for earnings and revenues served up by WisdomTree and RevenueShares.
Early reports so far point to positive earnings growth in the second quarter. The S'P 500 Index has reached new highs in the quarter after rough winter weather dampened growth early in the year. But the recovery appears to be continuing, which is helping earnings.
“Seventy-seven percent of the 82 companies in the S'P 500 that have posted results this earnings season beat analysts’ profit projections, and 70 percent exceeded sales estimates,” said Sumit Roy, managing editor of Hard Assets Investor, citing Bloomberg data.
Investors analyzing financial results are looking at revenues and earnings. Earnings have been pumped up in recent years by cost cuts, but as the job market improves revenue growth will spill down and fuel increasing amounts of earnings growth as well. So. from an ETF investor perspective, is an ETF that screens for earnings better, or is one that screen companies for revenues?
“Both could be valid approaches,” said Spencer Bogart, an ETF analyst at ETF.com. “The entire idea behind this type of alternative weighting is to say ‘let’s stop using market capitalization (which relies on stock price) to determine the relative size of companies, because market price itself is subject to emotional swings from investors.”
Top Or Bottom?
Revenue is often referred to as the “top line” and is the company’s gross profits, while earnings are called “bottom line,” which refers to the company’s net profits.
As noted, WisdomTree and RevenueShares currently offer investors samples of their own brands of earnings and revenues-focused ETFs, respectively. They are organized around size of companies, allowing for one-to-one comparisons. They are:
WisdomTree’s suite of earnings-focused ETFs:
- WisdomTree Earnings 500 ETF (EPS | B-95)
- WisdomTree MidCap Earnings ETF (EZM | A-75)
- WisdomTree SmallCap Earnings ETF (EES | A-87)
RevenueShares’ suite of revenue-focused ETFs:
- RevenueShares Small Cap ETF (RWJ | B-82)
- RevenueShares Mid Cap ETF (RWK | C-73)
- RevenueShares Large Cap ETF (RWL | B-87)
WisdomTree’s ETFs are self-indexing funds, while RevenueShares’ ETFs are based off of S'P indexes. It’s also interesting to note that performance results are mixed this year for investors who have chosen one set of funds over the other.
So let’s get into the comparison:
1) Large-Cap ETFs:EPS Vs. RWL
Year-to-date, WisdomTree’s EPS is up 8 percent, while RevenueShares’ RWK has gained about 7 percent. EPS currently has large-cap stocks such as Apple, Exxon and Microsoft as its biggest holdings, while RWL’s top holdings are Walmart, Exxon and Chevron.
EPS has an expense ratio of 0.28 percent, or $28 for every $10,000 invested, while RWL’s expense ratio is 0.49 percent.
2) Midcap ETFs:EZM Vs. RWK
In the midcap space, EZM is slightly lagging RWK this year, with returns of 5.9 percent versus 6.1 percent for RWK. EZM has a heavier exposure to the financials and industrials sectors. EZM currently includes Liberty Interactive Group, which consists of TripAdvisor, Expedia and American Airlines, and it also holds Joy Global, a maker of mining equipment.
RWK’s heavy focus on consumer cyclicals include electronics maker Ingram Micro; World Fuel, a global fuel supplier; as well as Tech Data, a distributor of tech products.
RWK’s annual expense ratio is 0.54 percent, or $54 for every $10,000 invested, versus 0.38 percent for EZM.
3) Small-Cap ETFs:EES Vs. RWJ
Charts courtesy of StockCharts.com
In the small-cap space, EES has recorded a loss of 1.2 percent year-to-date, while RWJ has gained about 1.5 percent. Small-caps tend to outperform larger-caps early in an economic recovery, and the fact that these two ETFs are lagging the other two sets of ETFs being compared here is emblematic of that. After all, the current rally in stocks is five years old.
In any case, both funds have a healthy exposure to consumer cyclicals, with EES’ current top holdings being American Axle Manufacturing, an auto component maker; as well Cooper Tire ' Rubber and MDC Holding, a homebuilder.
RWJ’s top three holdings include health care concern Centene Corp.; information tech company Synnex Corp.; and Group 1 Automotive, an auto retailer.
EES sports an expense ratio of 0.38 percent, or $38 for every $10,000 invested, while RWJ charges 0.54 percent.
Getting To The Bottom Line, Sort Of
According to Bogart, investors who use earnings as a gauge may wind up with companies in their portfolios that don’t fit the bill.
For example, Bogart said a company that’s doing well might invest some of its increased revenue on business development, thus detracting from earnings. That, in turn, would result in the company becoming a smaller portion of an earnings-weighted portfolio.
Meanwhile, a relatively disadvantaged company in the space might recognize its poor positioning and decide to keep expenses low and milk whatever earnings it can. The result here would be that an earnings-weighted portfolio would give a heavy allocation to the competitively disadvantaged company and a much lighter allocation to the competitively advantaged company—exactly the opposite of what investors would want in their portfolios.