Reporting season for Australian companies is around the corner and following that is the reconstitution Russell Investments High Dividend Australian Shares ETF (RDV) holdings. This is where our fund manager adds in or takes out stocks based on their likelihood to pay good dividends.

RDV’s underlying index is reconstituted twice a year in March and September. This timeline allows consensus forecasts (which feed into the underlying methodology or how stocks are selected) to be updated after companies report on earnings in February (half-year) and August (full-year).

The underlying methodology of RDV aims to build a portfolio that pays a relatively high gross dividend yield to investors versus the broad Australian market and provide investors with a consistent source of income. Whilst it is important to look at the historical dividend characteristics of a stock, RDV’s methodology also focuses on forecast dividend yields as well as a stock’s earnings variability or how its earnings goes up or down, to assess whether a stock is suitable for the portfolio.

To get an idea of how RDV may be positioned after this February’s reporting season, we can take a look at an example from last year’s reconstitution, to see the type of stocks that get added to the fund or taken out.

During the end-March 2019 reconstitution, JB Hi-Fi(JBH) was added to RDV at a weight of 2.2%, based on the underlying yield characteristics of the stock. That is, we tested JBH and saw it as a good dividend payer.

And didn’t it deliver! As of 20 January, 2020, JBH stock returned 64.8% since being put into RDV and clearly has added real value for the investors.

Why was JB Hi-Fi added to the portfolio in March 2019?

At the time of the RDV reconstitution, JBH scored well relative to other large cap stocks on both forward-looking and historical metrics or key numbers:

• Forecasted dividend yield is an important metric for investors, as it is the expected yield that would be received if buying a stock today. Whilst historical or past yields can be a guide to future yields, using consensus forecasts for dividends provide a more robust  estimate. At reconstitution, JBH was trading on a forecast gross yield of big 9.22%. The average forecast gross yield for the large cap universe of stocks was only 5.47%;
• Companies that have a history of growing dividends tend to continue to pay higher dividends in future. At the March reconstitution, the average three-year dividend growth of companies in the large cap space was 7.04%. In contrast, JBH had grown dividends over the same period by 14.08%, rewarding investors with higher dividends as the company’s earnings grew;
• The volatility of a company’s earnings is a vital metric when assessing the potential to pay dividends. A company where earnings vary, going up and down, has a higher chance of paying infrequent dividends or cutting the amount paid to investors when earnings fall. On the other hand, companies with more steady earnings streams tend to pay more constant dividends or increase the payouts to investors over time. Relative to large cap stocks in Australia, JBH has not exhibited extreme earnings variability over the five years to March 2019, which gives some comfort that there is not high risk of the forecast dividend being cut or scrapped.

What has happened since JB Hi-Fi was added to RDV in March 2019?

In May 2019, the surprise federal election result, which saw the LNP retain government, drove the Australian equity market higher, as the market was pricing in a result that would have negative impacts for the economy. Before the election, economic growth forecasts had been downgraded and economically sensitive segments of the market, such as retailers, had been underperforming. In short, JBH was out of favour as there was significant negative news priced into the stock. The election result drove a significant pickup in consumer sentiment and the stock rallied over 14% up to when the company reported in August, alongside other retailers. The company reported FY19 earnings in line with expectations and increased its dividend relative to the previous year which was well received by investors. After a positive sales update in October, the company continued to rally through the end of 2019 and into 2020, further buoyed by a strong overall retail sales numbers in Australia.

Since JBH was added to RDV, the stock has returned 64.8% compared to the broad market return of 18.9%, as at January 20, 2020.

RDV’s position in JBH showcases RDV’s methodology for selecting stocks. The example shows specifically how looking at metrics other than the trailing dividend yield of stocks, such as the forward-looking yield of a stock and its earnings variability, along with a commitment to find diversified sources for yield, results in the portfolio delivering a solid overall return for investors.