Earnings reports are the most important pieces of information divulged by public companies. Knowing that, a case can be made that weighting an index by earnings could prove to be an efficacious strategy over the long term.
Trend Of Success Necessary
Among mid-cap stocks, the WisdomTree MidCap Earnings Fund (ETF) (NYSE: EZM) proves that weighting by earnings is indeed a winning long-term strategy. EZM, which celebrates its tenth birthday in February, follows the WisdomTree MidCap Earnings Index. To be included in that index, companies must have at least four consecutive quarters of positive earnings.
The Growth Appeal Of Mid-, Small-Cap Stocks
Many investors consider mid- and small-cap stocks for growth prospects and are willing to sacrifice profitability in those companies as long as the market bids those names higher. EZM allows investors to tap the advantages of the mid-cap segment without being exposed to companies that are struggling to turn a profit.
Currently, EZM devotes nearly 13 percent of its combined weight to rate-sensitive utilities and real estate stock, sectors that have helped drive the ETF higher this year. EZM is overweight utilities and underweight real estate relative to the S&P MidCap 400 Index.
Further Support For EZM
“This has been another very strong sector in 2016, and, as in the case of Utilities, the income-generating capability of the real estate constituents has found favor in today’s low-rate environment. The WisdomTree MidCap Dividend Index is a 4.1 percent over-weight, whereas the WisdomTree MidCap Earnings Index is a 4.7 percent under-weight when measured against the S&P MidCap 400 Index,” said WisdomTree in a recent note.
EZM's larger sector allocations are cyclical, indicating the ETF is well-positioned to continue delivering for investors if interest rates rise. Industrials, financials, consumer discretionary and technology stocks combine for about two-thirds of the ETF's weight.
Bolstering the case for mid-caps, particularly those of the profitable variety heading into 2017, is speculation by some market observers that next year will be a record year for mergers and acquisitions activity. Profitable mid-caps dwelling among EZM's largest sector allocations could make for compelling takeover targets for large-cap companies.
A Word Of Caution
An issue that fundamentally-weighted ETFs, such as EZM, encounter is the widely held belief that holding a simple, traditional index over the long-term is the best way for conservative investors to generate solid returns. EZM proves different. At the very least, EZM proves different can be rewarding.
Since the start of the current bull market, the S&P MidCap 400 and the S&P MidCap 400 Growth Index are up 284.5 percent and 311.3 percent, respectively. EZM is higher by 354 percent over the same period while displaying comparable volatility to the aforementioned mid-cap benchmarks.
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