Most indexes and the exchange-traded funds (ETFs) that track them weight stocks by market capitalization—a method that assumes price and market valuations are always the best measure of true value. But, when company, sector or market valuations don’t reflect the true underlying value, you may not only be paying higher prices but also taking on higher risks—and typically with far less reward.
Why weight by earnings
We believe earnings are a better indicator of underlying value than stock price alone and that stocks with higher earnings—and therefore lower price-to-earnings (P/E) ratios—can outperform others. And as you can see below, Wharton Professor Jeremy Siegel, a senior WisdomTree Advisor, demonstrated that stocks with lower P/E ratios outperformed those with higher P/E ratios.
At WisdomTree, we weight by earnings because we believe it can help lower the P/E ratio for the given market, manage valuations and magnify the effects earnings have on risk and return characteristics.
How we weight by earnings
WisdomTree combines the performance potential of active management and the benefits of a passive index approach with all the structural and cost advantages of ETFs to create strategies designed to perform. For our earnings ETFs, we weight companies by the earnings they generate, rather than by market cap. As you can see in the hypothetical example below, using the same initial investment and the same three stocks, the earnings-weighted portfolio has a P/E ratio that is more than 20% lower than the market cap weighted portfolio. We believe this can help enhance performance and reduce risk.
Rebalancing Based on Valuations
Once a year, we not only adjust weights back to relative value, but we also eliminate any companies with negative earnings. We believe this is critical to maintaining lower P/E ratios and helping ensure investors don’t overpay for the markets.
Our earnings family
WisdomTree’s family of earnings-weighted strategies combines the performance potential of active investments with all the advantages of ETFs. They are designed to help lower the price of the markets and magnify the effects earnings have on risk and return.
WisdomTree U.S. TOTAL EARNINGS FUND
The WisdomTree U.S. Total Earnings Fund allows investors to gain exposure to profitable U.S. equities of all cap sizes while managing valuation risk.
WisdomTree U.S. EARNINGS 500 FUND
The WisdomTree U.S. Earnings 500 Fund provides investors with the stable growth potential of profitable U.S. large caps with potentially less valuation risk.
WisdomTree U.S. MIDCAP EARNINGS FUND
By managing valuations, the WisdomTree U.S. MidCap Earnings Fund helps investors capitalize on the growth potential of profitable mid-sized companies with potentially less valuation risk.
WisdomTree U.S. SMALLCAP EARNINGS FUND
Weighting by earnings enables the WisdomTree U.S. SmallCap Earnings Fund to provide the growth potential of profitable small-cap companies while managing valuation risk.
View our blog to learn more about Earnings ETFs.