DEM: Emerging Markets’ Valuation, Dividend Yield And EPS Growth Come Together (DEM)

Stocks peaked about a month ago. Since late March, the S&P 500 has been down about 3%. Nothing to write home about in terms of a market correction, but it’s generally red across the board. One area that has been a quiet outperformer lately, though, is emerging markets.

In a plot twist, EM has benefited from a steep rise in China equities over the past three months. It comes just when so many pundits deemed China “uninvestable.” But, as that nation’s stock market has rallied above its 200-day moving average and notched fresh 2024 highs, it’s worth giving another look to the WisdomTree Emerging Markets High Dividend Fund ETF (NYSEARCA:DEM).

I am upgrading the fund from a hold to a buy. After underperforming the US stock market for the better part of the last year, relative strength has improved while DEM’s valuation remains attractive. Broad EM now trades at just 12.9 times earnings with multiples in the 8 to 11 range in China, seemingly pricing in a potential war between China and Taiwan. What’s more, analysts’ EPS estimates for EM call for a whopping 20% increase this year, which could mean a much lower realized P/E come 2025.

EM Equities Seven Turns Cheaper Vs SPX Stocks

Strong EPS Growth Expected Across EM Through 2026

According to WisdomTree, DEM seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Emerging Markets High Dividend Index. The ETF allows investors to gain exposure to EM equities across the market cap spectrum, with an emphasis on high dividend yield companies. DEM can be used to diversify geographical and style exposure.

DEM is a moderate-sized ETF with $2.8 billion in assets under management as of April 26, 2024, up from $2.1 billion this time last year. The fund pays a high 5.6% trailing 12-month dividend yield, more than twice that of other broad index EM ETFs. Share-price momentum has improved in recent months, rising from a C- ETF Grade by Seeking Alpha in January to a solid B- today.

DEM’s annual expense ratio is moderate at 0.63%, and considering its exposure to nascent corners of the investable universe, the fee is not overly high. In terms of risk, the ETF doesn’t have an exorbitant historical standard deviation and the portfolio is decently diversified across sectors. Finally, DEM sports a robust liquidity grade given average daily volume of more than 300,000 shares while its 30-day median bid/ask spread is just two basis points.

EM Offers A High Yield

What makes DEM unique compared to other emerging-markets ETFs is that it employs a dividend-weighted construction and fund management approach. Rather than owning equities based on their relative market cap size, dividends offer a different spin on portfolio management. The thinking here is that dividends are an objective measure of a company’s health and profitability profiles.

By weighting holdings based on their dividend streams, rather than by market cap, DEM can enhance returns and potentially reduce volatility compared to traditional asset allocation approaches. The issuer notes that over the long haul, DEM has produced strong relative performance with controlled volatility compared to the MSCI Emerging Markets Index over the same timeframe.

The Difference Dividend Weighting Makes (Hypothetical Illustration)

So, how does WisdomTree go about selecting securities for index and fund inclusion? The process begins with filtering the EM index by certain market cap and liquidity requirements as not all stocks across the emerging markets universe are practically investable. The quantitative fund then screens for firms that have positive trailing 1-year earnings that also pay dividends.

From there, the process removes the bottom 70% of companies meeting the basic requirements. The most volatile stocks are then filtered out. I like this approach since it can reduce long-term volatility by owning profitable dividend payers and not doomed zombie companies or firms that face a higher risk of being forced to slash their dividends.

Investment Process: WisdomTree Emerging Markets High Dividend Index

Digging into the current portfolio, the 4-star, Gold-rated fund by Morningstar plots in the upper-left section of the style box. The large-cap value-oriented portfolio has just 2% exposure to the growth style.

Of course, that’s a risk if major US TMT stocks assert their dominance in the global marketplace. If we see a return to glory within certain cyclical and defensive areas, then I would expect DEM to produce alpha to the S&P 500. There is also some market-cap diversification as 16% of the ETF is considered mid-cap and there’s a modest 4% small-cap exposure.

As it stands, DEM trades at just 8 times earnings, resulting in a PEG ratio that is less than one when factoring in the fund’s long-term EPS growth rate history.

DEM: Portfolio & Factor Profiles

Now could be the right time to get long DEM compared to ex-China EM ETFs. China is 21% of the allocation and Taiwan is more than one-quarter of the fund. While about half of DEM is focused in Southeast Asia equities, there is access to other strong markets like Brazil and Mexico. India, another popular EM play, is a material 7% of DEM today.

For DEM to work, we need to see cyclical-value sectors step up. Financials and Energy combine for more than 45% of the ETF. Materials and Industrials tag team for another 18%. Info Tech, Communication Services, and Consumer Discretionary are only about one-quarter of DEM – just shy of half the weight compared to the S&P 500.

DEM: Portfolio Holdings, Sector Positioning, Country Allocation

Seasonally, now has historically been the start to DEM’s rough calendar stretch. The May through October period has produced negative returns cumulatively over the past decade, so that’s a bearish sign.

Of course, technicians will say that seasonality comes second to price-action momentum. Still, it is something to keep in mind as all those “sell in May and go away” calls make the rounds over the coming weeks.

DEM: Bearish Seasonal Trends Through October Suggest Some Caution

The Technical Take

Focusing on the chart, DEM has some solid trends in my view. Notice in the graph below that shares recently hit levels not seen in about two years. The ETF notched its cycle low in November 2022, shortly after the S&P 500 began its recovery. A 10% pullback last summer and into the fourth quarter brought DEM under its long-term 200-day moving average. But the trend indicator line remained generally positively sloped throughout much of last year and continues higher through today. Moreover, shares broke out above key resistance levels between $40 and $41 back in February. DEM then tested previous resistance during its April pullback.

Today, as the RSI momentum oscillator at the top of the chart ranges from 30 to 70, the bulls are generally in control of the technical trend. Additionally, there is now a significant amount of volume by price under the latest price and down to about $36. That should offer a cushion if DEM endures protracted selling pressure over the latter half of the second quarter.

Overall, with a rising 200dma, shares defending support near $40, and a broad uptrend in place following last year’s correction, technicals appear healthy for DEM.

DEM: Uptrend in Place, Shares Above Former Resistance

The Bottom Line

I am upgrading DEM from a hold to a buy. Its valuation remains very cheap, particularly considering EM’s forecasted earnings growth this year and next. With a robust screening process and improved technicals, shares appear poised to continue higher in 2024.