Royal Value Trust: 8% dividend yield with rising valuation (NYSE: RVT)
Royce Value Trust (NYSE: RVT) invests in small and micro businesses that operate primarily in the United States and other developed markets. The fund has outperformed the benchmark Russell 2000 index since its inception in 1986, with a total return of 11.07%. each year, compared to the benchmark return of 9.85%. So, RVT has a long-term and consistent track record that has worked quite well. As such, the current market downturn has resulted in considerable value to RVT, as investments in small cap stocks react more strongly to a market downturn and general risk aversion. As a result, we are now seeing very high dividend yields on RVT, exceeding 8% and we expect the same for their futures contract. forecast. This article discusses the merits of RVT as an investment and its attractive valuation through the dividend growth model.
Macro on small cap, value style
During market declines, the small cap segment of the stock market in which RVT invests tends to underperform. This is due to the higher beta nature of this segment, and for the case of RVT, the beta is 1.44 times. This means that if the stock market moved 10% down or up, the RVT would typically move 14.4% in the same direction. Given the current market conditions with the war and general risk aversion, RVT has therefore declined. However, as soon as there is news of peace talks between Russia and Ukraine and inflation starts to subside due to the subsequent decline in commodity prices, RVT should be able to do better. . A high beta also means that RVT is well positioned to participate in a cyclical market rally.
Additionally, the value space that RVT is focused on is poised to do well when investors are nervous about growth stocks and disappointed following the 2021 stock craze. When markets think of value stocks, fundamental investment principles come to mind. Over the long term, small cap stocks have also outperformed their larger counterparts. According to Royce Investment Partners, the total return performance of small-cap value stocks is expected to outperform growth stocks, as “small-cap value is still valued near the bottom of its 20-year valuation range relative to growth.” small cap”. As a longer term investment, RVT is well positioned as the total return of small cap stocks has exceeded that of large cap stocks, an observation confirmed by Schroders and Barron’s. Also, as we’ll explain below, RVT’s top holdings are generally cheaper based on valuation multiples.
Chart 1: Long-term performance of small caps versus large caps
Valuations and dividend indicators are mostly in the “green zone”
The heatmap below shows Seeking Alpha forward (FWD) price-to-earnings (P/E) and price-to-book (P/B) valuation ratings, as well as Seeking Alpha’s dividend quality indicators, for the top ten holdings of Royce Value Trust. Cells shaded green are those within grade A and grade B bands, yellow represents grade C band, and red represents grade D and F bands (blank cells are due to lack of data or to a list of countries outside of the United States). The good news is that 16 of 34 (47%) shaded cells are in the green zone, 11 of 34 cells (32%) are in the yellow zone, and 7 of 34 cells (21%) are in the red zone. Therefore, the heatmap suggests that valuations and dividend quality indicators tend to be favorable to investors. In addition, the overall stock ratings of RVT’s holdings are predominantly “buy” rated.
Exhibit 2: Heatmap of Royce Value Trust’s top ten holdings, relating to P/E, P/B and dividend quality indicators
RVT’s top holdings are primarily core physical businesses, which showcase the best of value investing. Its main holdings, MKSI, KAI, FORM and CRUS, are in semiconductors and industrial equipment and these are undoubtedly booming sectors given the importance of automation today and the recovery of the manufacturing industry. The US Purchasing Managers’ Index (PMI) was at 57.1 in March and, although this was a month-over-month, it remained in expansion territory. KBR offers defense, intelligence, space, aviation solutions, segments that are currently profiting from the war. MOS sells fertilizers which have visibly benefited from soaring commodity prices and rising food prices. FSV offers residential and commercial property management services that are steady revenue generators, further benefiting from soaring real estate prices in the United States. MLAB is well positioned for the germ-sensitive post-COVID population, being involved in sterilization and disinfection products. Thus, the majority of RVT’s valuable holdings are in core industries, rather than high-growth sectors where future prospects may be uncertain.
Dividend Growth Valuation Model Suggests Many Upsides, Limited Downsides
The table below (Exhibit 3) shows RVT’s valuation calculations based on the dividend growth model. According to data from Seeking Alpha, RVT has had an annual dividend growth rate of 11% in each of the past five years. Exhibit 4 paints a picture that RVT has a long and consistent history of paying dividends that increase over time. Two scenarios are shown in Table 3 below, the first being a “conservative” scenario where the dividend growth rate is less than half the five-year historical average growth rate, at just 5%. The second scenario is the “optimistic” scenario where the dividend growth rate is closer to the historical average growth rate, although lower because the 4Q2021 dividend has been removed from the calculation because it is an outlier (i.e. $0.78, more than double the usual amount). In the conservative scenario, the fair value is $15.06, representing a 13.5% downside risk, while the optimistic scenario has a fair value of $43.64, suggesting an upside of 60.8 %. Of course, these are theoretical values that may not occur in the short term, but the main point of this depiction is that the risk-reward ratio (i.e. upside risk versus downside risk) decline) is favorably biased towards a long position.
Exhibit 3: Valuation of RVT based on two scenarios for the dividend growth model
|Cautious scenario: 5% dividend growth||Optimistic scenario: 10% dividend growth|
|Long-term expected return of the S&P 500 (annual)||ten%||Long-term expected return of the S&P 500 (annual)||ten%|
|Estimated risk-free rate in 2022||2.5%||Estimated risk-free rate in 2022||2.5%|
|Cost of equity||13.30%||Cost of equity||13.30%|
|Estimated dividend growth rate in 2023||5.0%||Estimated dividend growth rate in 2023||10.00%|
|Dividend estimated in 2023||1.25||Dividend estimated in 2023||1.44|
|Fair value – dividend growth model||15.06||Fair value – dividend growth model||43.64|
|Premium of current price ($17.10) over fair value||-13.5%||Reset from current price ($17.10) to fair value||60.8%|
Source: author’s model and calculations
Exhibit 4: RVT dividend distributions are consistent and stable with a growing trend
RVT’s technical charter looks promising
After touching the 100-day moving average (DMA) on March 7, RVT looks better positioned to rise, supported by RVT trading in the lower half of its Bollinger Band and its relative strength index at an oversold level. This drop to its 100-DMA was likely caused by the Russian-Ukrainian war, coupled with more aggressive rhetoric on interest rates by Fed Chairman Powell. Much of the macro headwinds have been priced into the price, but RVT’s steady dividends will likely keep it above the 200-DMA. Assuming RVT falls to its 200-DMA at $15.30, its forward dividend yield will be 9.4%. During a market downturn, we are likely to see better support for dividend payers such as RVT.
Exhibit 5: RVT may rebound after hitting the 100-day moving average
RVT is well positioned as its dividend payouts have a long-term track record and have been consistent. The company’s major holdings have high Seeking Alpha ratings on valuations and dividend quality. What’s comforting about RVT’s major holdings are its mostly physical companies, which means less worry about uncertain earnings growth rates. This factor will be important in maintaining dividend consistency and RVT’s ability to pay its dividend distributions, which are expected to yield more than 8%.
Given RVT’s long-term dividend history, it is possible to value RVT with a dividend growth model; Using this method, RVT’s valuation exhibits a significant upside of 60.8% assuming dividend growth remains at 10% each year and a relatively lesser decline of 13.5% assuming dividend growth declines to 5%. This represents a very good risk-reward ratio, and regardless, the historical and expected dividend yield has been in the high single digits in recent years. The technical chart on RVT is also attractive, as it has bounced off the 100-day moving average (DMA), suggesting that support has been found. If RVT falls to its 200-DMA, its dividend yield should exceed 9%.