By Philip van Doorn, MarketWatch
Eric Ervin, the CEO of Reality Shares, is concerned enough about the stock market that he favors a strategy that includes betting on a decline in prices heading into 2018.
Stock valuations are “continuing to be pressed further and further,” he said in an interview on Dec. 15. “The growth rates of a lot of these companies cannot sustain these multiples, so it is frightening.”
Reality Shares runs four exchange traded funds (ETFs) built around its Divcon stock-rating methodology.The firm was founded in 2012 and is headquartered in San Diego, with $145 million assets under advisement.
The Divcon methodology is designed to identify companies that are most likely to raise or lower dividends. A company’s Divcon rating ranges from 1 to 5, with 5 being the strongest ranking and indicating a high likelihood of a dividend increase. It makes no difference how high the dividend yield is. The idea is that companies that are well-positioned for dividend increases are more likely to be better stock-market performers over time.
The Divcon rating encompasses free cash flow/dividends, earnings growth, dividend actions, stock repurchases and other indicators.
Divcon ratings for the 1,200 largest publicly traded U.S. companies are available here . If the company doesn’t pay a dividend on common shares, it won’t have a Divcon rating.
For example, Lockheed Martin Corp. /zigman2/quotes/200691238/composite LMT -0.29% has a Divcon rating of 5. A scan of data supplied by FactSet shows that the company is paying annual dividends of $8 a share, while its free cash flow over the past 12 months totaled $15.82 a share. So the dividend has been very well-covered.
Here’s another example: CoreCivic Inc. /zigman2/quotes/200590180/composite CXW -0.60% (which changed its name from Corrections Corp. of America last year) has a Divcon rating of 1. The company is paying annual dividends of $1.68 a share, while its free cash flow over the past year has been $2.05 a share. This makes it appear the company is comfortably covering the dividend. However, CoreCivic cut its quarterly dividend payout by 22% in December 2016.
Reality Shares runs four ETFs based on Divcon. The first three listed here were established in January 2016, while the Reality Shares DIVS ETF was established in December 2014.
• Divcon Leaders Dividend ETF /zigman2/quotes/202627489/composite LEAD -0.07% — Invests in the largest U.S. companies that have the greatest probability of raising dividends over the next 12 months, based on Divcon scores.
• Divcon Dividend Defender ETF /zigman2/quotes/202491251/composite DFND -0.32% — Invests in the largest U.S. companies that have the greatest probability of raising dividends over the next 12 months, while investing 25% in short positions in companies with the highest probability of cutting dividends over the next 12 months, based on Divcon scores.
• Divcon Dividend Guard ETF — The allocation of this ETF depends on Reality Shares’ Guard Indicator, which forecasts the direction of the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.07% , based on technical measures of price volatility. Right now, GARD is invested the same way as LEAD. But if the Guard Indicator forecasts a market decline, up to 50% of the fund can be invested in short positions, making for more aggressive hedges and downside protection than DFND. However, the nature of the technical volatility indicators means “the market can decline 10% by the time the fund goes short,” Ervin said.
• Reality Shares DIVS ETF — This ETF is designed to protect investors from price volatility while generating a return to capture some of the increase in dividends for large-cap companies. The fund invests in dividend swaps. Ervin called its strategy an “alternative to bonds.”