Please ensure Javascript is enabled for purposes of website accessibility

Could These ETFs Be Your Ticket to Better Returns?

By Chris Jones – Updated Apr 6, 2017 at 12:47AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Can revenue-weighted ETFs consistently beat the market?

You can always find examples to prove the effectiveness of buy-and-hold investing . But unless you know exactly what you're doing, it's challenging to confidently construct a portfolio of long-term winning stocks. For those who prefer to steer clear of stock picking, exchange-traded funds (ETFs) provide the diversification benefits of index funds, with some of the convenience that comes from trading on stock exchanges.

Over the years, ETFs have become increasingly sophisticated. A "plain vanilla" ETF like the SPDR Trust tracks the market-cap-weighted S&P 500 index passively. But countless other ETF strategies have also become popular, from sector-specific ETFs to index ETFs that assign equal weightings to each component. Some of those methods have been successful, while others have been disastrous for investors.

It's not always the thought that counts
One such disaster is the dividend-weighted ETF. In theory, emphasizing dividend-paying companies seemed perfectly sound. Yet during the bear market, dividend stocks were among the worst-hit victims, especially those in the traditionally high-yielding financial sector. Moreover, because some dividend-weighted ETFs only made changes to their holdings once per year, they often held stocks long after their dividends had been cut.

Weighting component stocks by dividend isn't the only way to invest, however. Equal-weight S&P ETFs have beaten their traditional market-cap-weighted S&P funds in recent years, helping to boost their popularity.

Is revenue better than dividends?
Another strategy that has had good success is to weight stocks by their total revenue. Unlike dividend-weighted strategies, in which some index components will be entirely left out if they don't pay dividends, a revenue-weighted ETF will always own at least a small portion of every stock of the index.

Revenue-weighted ETFs give companies with the highest revenue the most representation in the fund, making current stock price a lot less important than it is in a traditional market-cap-weighted index. In other words, a revenue-weighted fund determines a company's importance based on its ability to generate sales, rather than its current stock price and number of shares outstanding.

One fund company, RevenueShares, has specialized in ETFs using revenue-weighted strategies. The company has had great success with its mid-cap and small-cap funds, which have beaten their market-cap-weighted SPDR ETF peers by two and 10 percentage points, respectively, since they began trading early in 2008. In the large-cap space, though, the RevenueShares ETF has underperformed the S&P 500 by about three percentage points.

One reason for the disparity may be that with large-caps, revenues track market capitalizations fairly closely. Although the weighting schemes are far from identical, you'll notice that several companies appear in the top 10 using both methods:

S&P 500 Constituent

Revenues (Millions)

Rev Rank

Cap Rank

Wal-Mart (NYSE:WMT)

   403,447

1

3

Exxon Mobil (NYSE:XOM)

   346,875

2

1

Chevron (NYSE:CVX)

   184,125

3

13

General Electric (NYSE:GE)

   170,940

4

8

ConocoPhillips

   166,891

5

27

AT&T (NYSE:T)

   123,723

6

9

Hewlett-Packard (NYSE:HPQ)

   117,205

7

17

Ford Motor (NYSE:F)

   113,850

8

100

McKesson

   106,585

9

146

Verizon Communications

   102,849

10

25

Source: Capital IQ, a division of Standard and Poor's. As of Oct. 5.

Another potential weakness of revenue-weighted ETFs is that they give greater weight to high-revenue, low-margin businesses than to smaller, more efficient companies. Whether that results in better or worse long-term performance remains to be seen.

Seeking the golden goose
Since ETFs arrived on the scene, their appeal as great diversification tools has faded somewhat. Now, investors want funds that will not just mimic the market, but actually outperform it on a consistent basis.

Such a golden goose has proven elusive so far, but innovative ETF companies continue to make progress toward that end, with new products coming out all the time. I expect that one day, we will see a new ETF that raises the bar for portfolio managers. With its stellar performance to date, the RevenueShares Small Cap fund has certainly become a prospective candidate in that regard.

If RevenueShares can apply that winning formula to its Large Cap and Mid Cap funds, it will be even closer to establishing its strategy as a serious contender for replacing traditional market-weighted ETFs in retail investors' portfolios.

Do you think a revenue-weighted strategy can beat the market over the long run? Share your thoughts in the comments section below.

Further reading:

Wal-Mart is a Motley Fool Inside Value recommendation. McKesson is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Chris Jones owns no shares of any company mentioned in this article. Nor is he short anything. When you're alone and life is making you lonely, you can always read The Motley Fool's disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Walmart Stock Quote
Walmart
WMT
$130.06 (-2.50%) $-3.33
HP Inc. Stock Quote
HP Inc.
HPQ
$25.35 (-1.40%) $0.36
Ford Motor Company Stock Quote
Ford Motor Company
F
$12.31 (-3.60%) $0.46
AT&T Inc. Stock Quote
AT&T Inc.
T
$16.01 (-1.42%) $0.23
Chevron Corporation Stock Quote
Chevron Corporation
CVX
$144.77 (-6.53%) $-10.12
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$85.75 (-5.32%) $-4.82
General Electric Company Stock Quote
General Electric Company
GE
$64.55 (-1.24%) $0.81

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.