What are we looking for?
High-yielding blue chips with attractive valuations that also excel in environmental, social and governance (ESG) factors.
Assets in quantitative (quant) funds and factor-based, or “smart beta” exchange-traded funds have grown at twice the pace of overall equity funds and ETFs since 2012. Sustainable and socially responsible funds have also experienced disproportionate growth relative to the overall market. A recent study by Merrill Lynch shows that a combination of the two themes can lead to especially profitable strategies. Over the back-tested period of 2005-17, one finding of the study was that an ESG overlay on a high-dividend-yield strategy would have increased the strategy’s return by three percentage points per year, and would have added two percentage points per year to a strategy focused solely on stocks with low forward-price-to-earnings ratios.
For value investors who are income-oriented, or simply prefer companies with high dividend yields, it could be a lucrative exercise to consider how companies score from an ESG perspective.
• We start with North American companies whose market cap is at least $20-billion, and filter for those whose next-12-month (NTM) SmartEstimate dividend yield is at least 3.5 per cent;
• Next, we look at forward (NTM) P/E, again according to SmartEstimate, and require a multiple of no more than 15.
• Finally, we consider the Thomson Reuters overall ESG score (the ESG metric used by Merrill Lynch in the study) and require a score of at least 80. This means it is in the top quintile relative to the universe of its global industry peers.
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What we found
Encouragingly for Canadian savers, each of the Big Five banks pass the screen, along with four blue-chip, household names from the United States – Chevron Corp., IBM, General Electric Co. and Prudential Financial Inc.
Chevron, both the largest company in the screen as well as the company with the highest ESG score (it doesn’t get penalized simply for being an oil and gas company – its score is relative to its global oil and gas peers), could benefit from recent news that Saudi Arabia and Kuwait are considering a restart of the oil fields that lie between the two countries in the partitioned Neutral Zone. Chevron holds a concession to operate Saudi Arabia’s 50-per-cent interest of the Wafra oil field, which averaged 78,000 barrels per day in 2014 before being shut down in 2015.
Among the Canadian lenders, Toronto-Dominion Bank has the highest ESG score, as well as the most exposure to the U.S. housing and retail market, which is healthier and less indebted than Canada’s. And TD’s $5.6-billion in excess capital is nearly triple that of the next closest bank. This high level is fuelling speculation the bank is eyeing more acquisitions in the United States, with analysts at both Desjardins Group and National Bank Financial citing E-Trade Financial Corp. as a potential target. TD owns 41 per cent of TD Ameritrade and a combination of E-Trade and Ameritrade would be the market leader in terms of volume of online traders. Also worth noting, TD’s management has stated it is considering buying another U.S. bank and E-Trade Bank, a subsidiary of E-Trade, could be divested to TD.
Full disclosure: The author owns shares of TD. Hugh Smith, CFA, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.