OUSA: High Quality Dividend ETF That Costs Too Much

Investment Thesis

The O’Shares U.S. Quality Dividend ETF (BATS:OUSA) is one of the highest-quality ETFs on the market. This monthly payer yields 1.77% and has matched the returns of more popular funds like the Vanguard Dividend Appreciation ETF (VIG) and the iShares Core Dividend Growth ETF (DGRO) in recent years. While this feature makes it a reasonably safe long-term choice, these two alternatives prove it’s unnecessary to pay OUSA’s excessive 0.48% expense ratio to access top-tier dividend-paying stocks. As such, I rate OUSA a “hold,” and I look forward to explaining why in more detail below.

OUSA Overview

Strategy Discussion

OUSA has tracked the ALPS O’Shares U.S. Quality Dividend Index since June 1, 2020, after previously tracking the FTSE USA Qual/Vol/Yield Factor 5% Capped Index since its inception on July 14, 2015. According to its website, the Index:

Is designed to measure the performance of publicly-listed large-capitalization and mid-capitalization dividend-paying issuers in the United States that meet certain market capitalization, liquidity, high quality, low volatility, and dividend yield thresholds. The high quality and low volatility requirements are designed to reduce exposure to high dividend equities that have experienced large price declines.

The Index evaluates a company’s quality and volatility features with six screens, as follows:

• profitability (return on assets)
• leverage (net debt-to-EBITDA)
• five-year dividend per share growth
• dividend coverage ratio (net income-dividends)
• five-year weekly standard deviation
• trailing-twelve-months regular cash dividends

The starting universe is the 500 largest U.S. stocks by market cap, and the Index selects the top 100 by their score-adjusted market caps while applying a 5% single security weighting limit. Additional statistics provided by Seeking Alpha are below, highlighting OUSA’s high 0.48% expense ratio and low $715 million in assets under management.

Performance Analysis

The following table highlights selected periodic returns for OUSA, VIG, DGRO, and the SPDR S&P 500 ETF (SPY) through March 31, 2024. Over the last three years, the three dividend ETFs gained about 29-30% and trailed SPY by 8-9%, mainly attributable to last year. OUSA underperformed VIG and DGRO by 8.43% and 2.53% in 2020, but that was a unique year, so I don’t want to penalize OUSA for its more defensive approach that year. You can read this analysis for evidence of why an ETF’s past returns are not good predictors of future returns.

OUSA Analysis

Sector Composition and Top Holdings

Instead, evaluating an ETF’s composition and fundamentals is more valuable. To begin, below is a table summarizing OUSA’s sector exposures and top three holdings in each, where applicable.

OUSA holds no stocks in the Energy, Materials, and Real Estate sectors and has minimal exposure to Utilities. It allocates 17% to Financials, but its selections aren’t nearly as volatile as the ones favored by high-dividend funds. JPMorgan Chase (JPM), Visa (V), and Mastercard (MA) are OUSA’s top three holdings in this sector, which have an average five-year beta of 1.05.

OUSA Fundamentals By Company

The following table highlights selected fundamental metrics for OUSA’s top 25 companies, totaling 64.01% of the portfolio. This concentration level is higher than VIG, DGRO, and SPY, so its lack of diversification is potentially problematic. However, that’s a necessary sacrifice for designing an ultra-high-quality portfolio. Notice how 24/25 stocks have 10/10 profit scores corresponding to “A+” Seeking Alpha Profitability Grades.

OUSA’s 9.86/10 profit score is supported by 16.90% weighted average free cash flow margins, which match SPY. OUSA is also competitive with SPY on EBITDA margins (33.96% vs. 32.21%), net margins (21.21% vs. 20.30%), and return on assets (11.60% vs. 12.36%). Therefore, there’s little doubt that OUSA is a high-quality ETF.

OUSA also has a low 42.55% dividend payout ratio and a solid 7.88% estimated earnings per share growth rate, which supports future dividend growth. OUSA’s current holdings have increased dividends by 10.23% per year over the last five years, and although an ETF’s dividend growth rate won’t always match the constituents’ dividend growth rate (see reasons why here), it’s evident OUSA’s selection process works as advertised. 51% of the portfolio by weight have double-digit five-year dividend growth rates, and 86% have “A+” Profitability Grades. Nevertheless, there are two issues, as follows:

1. The first issue is OUSA’s 0.48% expense ratio, which reduces the net expected dividend yield from 2.19% to 1.71%. It’s a significant flaw for dividend growth investors, as it means the yield on cost won’t rise to an acceptable level for quite some time, even with a high dividend growth rate. This is illustrated in the graph below, which demonstrates how a 2% yielding portfolio with a 7% annual dividend growth rate (Portfolio C) produces far less income than a 3% yielding portfolio with a 6% dividend growth rate (Portfolio B) after 25 years.

2. The second issue is that despite OUSA’s robust quality and dividend growth features, VIG is also quite solid. VIG trades at 21.73x forward earnings and has a 7.08% estimated earnings per share growth rate, both competitive with OUSA. In addition, its 16.01% free cash flow margins and 40.29% dividend payout ratio indicate it’s also capable of delivering strong dividend growth moving forward. Finally, it’s better diversified, with only 51.10% of assets in its top 25 holdings. Investors can move closer to value territory with DGRO (lower P/E, less growth, lower quality, higher yield). Still, the main takeaway is that you don’t need to pay high fees for a portfolio of quality dividend stocks.

Investment Recommendation

Due to competitive lower-fee options, I do not recommend readers buy OUSA. The selection process and the portfolio’s fundamentals are fine, but alternatives like VIG and DGRO feature higher dividend yields, reasonable value and growth combinations, and are better diversified. Therefore, I have assigned a “hold” rating to OUSA. Thank you for reading, and I look forward to your comments below.