Is DIA a Better Bet Than SPY?

by Daniel Putnam | August 2, 2012 1:20 pm

Investors who are looking for broad exposure to the U.S. market typically choose the SPDR S&P 500 ETF (NYSEARCA:SPY[1]), as evidenced by its massive $108.8 billion market cap and its status as the largest ETF in the country. Another S&P 500–linked ETF, iShares S&P 500 (NYSEARCA:IVV[2]) isn’t far behind with a $30.7 billion market cap and a No. 7 ranking.

While nobody’s complaining about the strong three-year performance and minuscule 0.09% expense ratios of these ETFs, those who have gravitated to SPY and IVV have missed out on the stellar relative performance of another broad-based domestic fund, the SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA[3]). DIA has delivered superior returns across all time periods:

DIA 12.20% 14.96% 1.81% 7.01%
SPY 11.97% 13.74% 0.64% 6.73%


What’s going on here? The Dow isn’t exactly known for being a source of beta. But dig below the surface, and three important factors stand out as the reasons for its outperformance:

  1. DIA has a smaller weighting in financials than SPY (9.5% vs. 14.2%), which has helped cushion it from some of the sector’s massive underperformance in the post-crisis period. The Select Sector SPDR-Financial ETF (NYSEARCA:XLF[5]) has a five-year average annual return of -13.38%, more than 14 percentage points behind the broader market.
  2. DIA also has a much larger weighting in certain defensive stocks that have performed exceptionally well in the past three years, namely McDonald’s (NYSE:MCD[6]), (+78%); Coca Cola (NYSE:KO[7]), (+78%); and Wal-Mart (NYSE:WMT[8]), (+59%).
  3. Finally, and perhaps most important, the Dow’s approach of holding an equal-share weighting in each of its 30 components means higher-priced stocks have a larger impact on its return than those with prices in the teens and below. As a result of this structure, eight Dow components have weightings of 2% or less — including giants such as Microsoft (NYSE:MSFT[9]) — at the same time as IBM (NYSE:IBM[10]) has an enormous weighting of 11.4%. (Comparatively, the largest position in SPY — Apple (NASDAQ:AAPL[11]) — is weighted at just 4.6%). The result is that IBM has had a massive influence on the Dow’s performance. That’s good news for DIA investors, since IBM’s three- and 10-year average annual returns are 19.7% and 12.7%, respectively.

Whether or not DIA can continue its long-term outperformance is in large part a function of these three trends. To hold DIA in favor of another broad-based ETF is essentially a bet that financials will keep underperforming, while IBM and the defensive names keep trending higher.

There’s nothing to suggest any of these trends will change right away — and IBM appears undervalued[12] — but investors still need to understand that different factors will drive DIA’s performance relative to SPY.

The table below shows how the two ETFs stack up. While SPY offers better growth and is more cheaply valued by certain measures, DIA has the edge in terms of yield, P/E and volatility statistics. The volatility measures are an interesting consideration, because they show that DIA has been able to achieve its superior returns not by having a higher-risk portfolio, but through the strong performance of its underlying holdings.

Expense Ratio 0.18% 0.09%
30-Day SEC Yield 2.41% 1.94%
Est. 3-5 Year Earnings Growth 8.99% 10.68%
Trailing P/E 13.7x 14.6x
Forward P/E (1-Year) 12.5x 13.3x
Price-to-Book 2.68 2.10
Price-to-Cash Flow 7.78 7.63
Return on Equity 30.2% 31.2%
Weighted Market Cap $14.8 B $11.4 B
Annualized Volatility 14.41 15.88
Beta vs. S&P 500 0.88 0.99

Put it all together, and it appears that DIA can continue to act as a sound option for investors looking for a core domestic large-cap holding. You just need to be aware of exactly what you’re buying.

  1. SPY:
  2. IVV:
  3. DIA:
  4. [Image]:
  5. XLF:
  6. MCD:
  7. KO:
  8. WMT:
  9. MSFT:
  10. IBM:
  11. AAPL:
  12. appears undervalued:

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