How This Mid Cap Index Became Less Pricey Despite Strong Gains

equity
gannatti
Head of Research, Europe
04/01/2015

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?   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.
About the Contributor
gannatti
Head of Research, Europe

Christopher Gannatti began at WisdomTree as a Research Analyst in December 2010, working directly with Jeremy Schwartz, CFA®, Director of Research. In January of 2014, he was promoted to Associate Director of Research where he was responsible to lead different groups of analysts and strategists within the broader Research team at WisdomTree. In February of 2018, Christopher was promoted to Head of Research, Europe, where he will be based out of WisdomTree’s London office and will be responsible for the full WisdomTree research effort within the European market, as well as supporting the UCITs platform globally. Christopher came to WisdomTree from Lord Abbett, where he worked for four and a half years as a Regional Consultant. He received his MBA in Quantitative Finance, Accounting, and Economics from NYU’s Stern School of Business in 2010, and he received his bachelor’s degree from Colgate University in Economics in 2006. Christopher is a holder of the Chartered Financial Analyst designation.