How To Research An ETF

| September 12, 2008 | 0 Comments

I read the Wall Street Journal every day.  I have for years.  It’s the one publication that every professional investor I know reads regularly. Reading the Journal’s become a habit for me.  I start off every day getting up to speed on all the important business news.

But the Journal’s not alone.

There’s a handful of other magazines and newsletters I read also.  It’s amazing the amount of information I can devour over the course of a week.  Often times you’ll get the best investment ideas from the strangest places.

As a matter of fact, just this week I found something really interesting . . . An ETF you shouldn’t buy (and I’d actually sell it if I owned it).

I know it’s strange. I’m always talking about how great ETFs are.  I’m always going on and on about their low cost, instant diversification, and the way they make playing trends easy.  I like ETFs so much, they make up the majority of my retirement account.

But then I found an ETF you shouldn’t buy.

And if you own it, I’d consider selling it.

I’ll tell you why in a moment.  But first let me tell you how I found this horrible ETF.

Like I said, I love to read the Wall Street Journal.  They’ve got tons of information on individual companies, industries, and the market in general.  In the Money & Investing section they publish a boatload of data.  So much so, I normally ignore it.  It can be quite overwhelming.  If you read the Journal, I’m sure you know what I mean.

Anyway, earlier this week I was studying some of tables of information. One area that caught my eye was the high yield list.  Capturing a good yield on a stock is never a bad idea (or so I thought).

I couldn’t believe what I found.  Smack dab at the top of the list.  An ETF yielding 17.49%.  Let me tell you, I got really excited.  But I knew I had to do some research.

The first thing I did was verify the yield.  Normally you can trust the data in the Journal, but it never hurts to double check.  Nobody’s perfect, and mistakes do happen.  Sure enough the data was wrong.

I looked on Yahoo.  They listed their last dividend payment as late 2007. I knew that couldn’t be right.  So I went right to the source.  I visited the fund website.  There I could download the ETFs historical prices and dividend table.  The last dividend paid (last quarter) was $0.75.  So a little quick math – $0.75 times 4 is an annual dividend of $3.

The ETFs trading at $20 per share.  So that makes the dividend yield closer to 15%.

Not quite the 17.5% I was expecting, but a good number nonetheless.

So I researched this ETF a little further.  The size of the fund was small ($28 million in assets) but I’ve seen smaller.  And for a big yield, I’m willing to let that issue slide.  The liquidity on the fund was “OK”.  It traded around 25,000 shares a day.  Not great, but I wasn’t going to be buying a huge number of shares – at least not right away.  Then I checked out the management fee, a respectable 0.48%

So far so good. Just a few more things to research.

The next step was looking at the ETF holdings.  The fund held 23 different securities.  Again, not great, but I could live with it.  I normally like to see at least 20 companies for good diversification.  As I reviewed the holdings, it dawned on me why the yield was so high.  Most of the companies were in the mortgage finance industry.

That was the first red flag.

I was still salivating over that 15% yield.  So I was willing to take on the risk of investing in a downtrodden industry.  So I continued my research. That’s when I discovered the facts that turned my stomach.  It was just a little number.

But it told me flat out – don’t buy this ETF.

What was it?

It was the percentage holdings.  I like ETFs because of their diversification.  This fund’s top two holdings (YES just 2 companies) accounted for more than 40% of the fund’s assets.  It kind of defeats the purpose of being diversified, don’t you think?

If I wanted to put half of my money into two stocks I’d go out and buy those stocks . . . why buy the ETF at all.  Definitely a red flag, and a big one at that.  It told me to stay away!  The risk was too great.

So what ETF was I researching?  It was the iShares FTSE NAREIT Mortgage REITs (REM).  Despite its high yield, I’d stay away from this ETF.  Its holdings are too concentrated.  If one of those two top holdings hits a rough patch, you can kiss your investment goodbye.  By the way, if you hold this ETF you might consider selling it.

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Category: ETFs

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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