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Trying To Find Safety With Small Caps

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Trying To Find Safety With Small Caps

Small-cap stocks and exchange traded funds are anything but safe these days. Among the various market capitalization segments; large, mid and small, smaller stocks were the first to officially enter bear markets during the recent equity market swoon.

Bold investors willing to mull small caps in 2019 may want to consider buffers, such as dividends and quality stocks.

What Happened

The WisdomTree U.S. SmallCap Quality Dividend Growth Fund (NASDAQ: DGRS) offers income-minded investors a quality approach to smaller stocks with the potential to reduce some of the volatility associated with the asset class.

But first, the bad news. Those traits, while favorable, don't make DGRS entirely immune to small-cap declines. Over the past 90 days, the ETF is down 20.5 percent. Now, the good news. DGRS is beating the Russell 2000 Index by 370 basis points over the past three months while being 410 basis points less volatile than the small-cap benchmark during that period.

Why It's Important

With interest rates rising, a lingering concern for many investors, regardless of company size, is the ability of a company to repay its debt.

“Of utmost importance for equity investors is the ability of these corporations to repay their obligations,” said WisdomTree in a recent note. “The increasing attention on identifying firms unable to pay debt servicing costs has resulted in a name for this distained class of profligate companies: zombies.”

As WisdomTree notes, roughly a quarter of the Russell 2000 Index's members have debt burdens that aren't sustainable.

“The WisdomTree U.S. SmallCap Quality Dividend Growth Index is a more selective cut of small caps, containing 272 constituents,” said WisdomTree. “The Index screens for companies with attractive growth and profitability characteristics on an annual basis, also in December.”

DGRS tracks the WisdomTree U.S. SmallCap Quality Dividend Growth Index.

What's Next

Importantly, DGRS member firms have superior interest coverage ratios and more attractive valuations relative to broader small-cap benchmarks.

“The WisdomTree U.S. SmallCap Quality Dividend Growth Index offers an interest-coverage ratio of over twice that of the Russell 2000, while at a significant valuation discount based on price-to-earnings,” according to WisdomTree.

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