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Careful, Yield Junkies: a Dividend ETF Stuffed With Pricey Utilities vs. One More Balanced

Dividend stocks have become a bit o’ the rage lately as income chasers have noticed that plenty of big-arse blue chips have dividend yields far above the yield on a 10-year Treasury. A few examples are Microsoft (MSFT), Johnson & Johnson (JNJ) and Intel (INTC):

JNJ Dividend Yield Chart

JNJ Dividend Yield data by YCharts

No surprise, that’s generated plenty of interest in exchange-traded funds (ETFs) that focus on dividend payers. The iShares Select Dividend ETF (DVY) has ballooned to an impressive $10.2 billion in assets. Its primary marketing hook: a fat 3.4% dividend yield.

Enticing, eh? But buyer beware.

The iShares Select Dividend ETF isn’t exactly the personification of diversified. Utility stocks account for 32% of the portfolio. That’s a tad more than the 4% utility weight in the S&P 500 stock index.

In terms of dividend yields, utilities are always the market leader. Standard & Poor’s says the sector yields an average of 4.1% right now; that’s more than twice the Treasury yield. But what might get lost in that yield delirium is that to get that dividend you have to buy the underlying stock, and utility stocks are flat out pricey right now. During the bumpy ride of the past three months where risk-off has dominated, the utility sector has motored forward.

^UTY Chart

^UTY data by YCharts

That’s just a replay of what happened from August to October of last year when worry over Europe and our debt-ceiling debacle sent the broad market south.

^UTY Chart

^UTY data by YCharts

The thing is, investor love for utility dividends has pushed their valuations way up. According to Standard & Poor’s, the utility sector within the S&P 500 is trading at a 15.4 price/earnings multiple based on 2012 estimates. That’s well above the 12.7 p/e for the overall S&P 500 index. S&P currently forecasts the broad index to have operating earnings growth of 6.4% this year, yet the utilities segment of the index is tagged for a 4.8% decline in per-share operating earnings.

If you’re angling for an ETF that delivers a more diversified dividend-paying portfolio, iShares High Dividend ETF (HDV) has 16% invested in the utility sector, half the weight of the iShares Select Dividend fund.

The ETF uses a screen developed by research firm Morningstar that puts a premium on companies deemed to have a strong predisposition to maintaining profitability going forward. The iShares High Dividend ETF outperformed the more utility-laden portfolio.

HDV Chart

HDV data by YCharts

Now that said, the iShares High Dividend ETF has a lower yield -- currently 2.5% -- than the iShares Select Dividend Select ETF, but High Dividend still manages a stronger total return.

HDV Total Return Price Chart

HDV Total Return Price data by YCharts

While it’s natural to get sucked in by a compelling yield, today’s tricky markets can reward investors who dive a layer deeper and make sure they understand the price they are paying for that current yield.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Read more articles about: Investing Ideas  

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