Dividends, Buybacks and the Prospect of Future Returns

Transcription

1 WisdomTree Research MARKET INSIGHTS [ May 2016 ] Dividends, Buybacks and the Prospect of Future Returns BY JEREMY SCHWARTZ, CFA, DIRECTOR OF RESEARCH, TRIPP ZIMMERMAN, CFA, ASSOCIATE DIRECTOR OF RESEARCH & JOSH RUSSELL, PHD, QUANTITATIVE EQUITY STRATEGIST As the U.S. equity market scales new heights, a debate is raging about the prospects for forward-looking returns. One argument states that the U.S. markets were unnaturally buoyed by the unprecedented balance sheet expansion and monetary easing 1 of the U.S. Federal Reserve (Fed). After the Fed s first interest rate 2 hike in almost a decade in December 2015 and the volatility 3 that endured at the start of 2016, market participants quickly lowered their expectations of the pace of further rate hikes. Of course, the starting point of the rate hike cycle is less important than where rates ultimately end up once the hiking cycle is complete. Here too there is wide debate. Another argument uses the price-to-earnings (P/E) ratio 4 of the S&P 500 Index, which ended the year at 23.6x reported earnings, to claim that, because it s above the historical average, valuations 5 must compress and mean revert. We believe the 2015 earnings were biased downward by the stronger dollar and losses in the Energy sector as a result of the 30% decline in oil prices, but if you look at a cyclically adjusted price/earnings (CAPE) ratio 6, around 26x at year-end, the market would look even more overvalued. Although using a cyclically adjusted number to try to smooth out changes from business cycle impacts makes sense intuitively, biases in the actual earnings calculation also make this number a challenge. Below, we suggest that an intuitive framework for future return expectations could be looking to dividends 7 and share buybacks 8, whose components often are referred to as shareholder yield 9 and are, we believe, important components of total returns. 1 Monetary easing: Actions undertaken by a central bank with the ultimate desired effect of lowering interest rates and stimulating the economy. 2 Interest rates: The rate at which interest is paid by a borrower for the use of money. 3 Volatility: A measure of the dispersion of actual returns around a particular average level. 4 Price-to-earnings (P/E) ratio: Share price divided by earnings per share. Lower numbers indicate an ability to access greater amounts of earnings per dollar invested. 5 Valuation: Refers to metrics that relate financial statistics for equities to their price levels to determine if certain attributes, such as earnings or dividends, are cheap or expensive. 6 Cyclically adjusted P/E ratio (CAPE): Price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years. 7 Dividend: A portion of corporate profits paid out to shareholders. 8 Share buybacks: Firms using cash to purchase their own outstanding shares; may positively impact the share price. 9 Shareholder yield: A data point that references the combination of dividend yield and buyback yield.

2 THE DIVIDEND DECOMPOSITION MODEL One way to frame returns on the market is a mathematical decomposition of the total returns over any period into three sources: 1. Price returns: a. The growth rate in dividends over the period in question b. The change in valuation (dividends/price) over the period 2. Impact of reinvested dividends over time (average dividend yields 10 over period) Over the last 10 years ending December 31, 2015, for the S&P 500 Index, dividends grew 6.92%, the average dividend reinvestment rate was 2.20% and total returns were 7.30%. Since the dividend growth plus the reinvestment rate (9.12%) was higher than the total return of 7.30%, there was a valuation compression of 1.81% per year. This means that the dividend yield ended the period higher than it started, as dividend growth outstripped price changes. In other words, the price-to-dividend 11 ratio fell over the last 10 years from 56.8x dividends to 47.3x dividends, with the market getting cheaper on a price-to-dividend basis. FIGURE 1: 10-YEAR RETURN DECONSTRUCTION 10.00% 8.00% 6.92% 7.30% 6.00% Percentage 4.00% 2.00% 2.20% 0.00% -2.00% -1.81% -4.00% Dividend Growth Return from Valuation Changes Average Reinvestment Rate Total Return Sources: WisdomTree, Robert Shiller, 12/31/05 12/31/15. Past performance is not indicative of future results. You cannot invest directly in an index 10 Dividend yield: A financial ratio that shows how much a company pays out in dividends each year relative to its share price. 11 Price-to-dividend ratio: Refers to the index price divided by the trailing 12-month dividends. 2

3 In the following chart, we look at a longer-term series of dividend growth over 10-year cycles. The median 10-year dividend growth over the full period has been almost 4%. The latest 10-year dividend growth was 6.92%, which ranks in the top 83% of all monthly observations since It is impressive to us that this 10-year period includes one of the greatest declines in dividends in modern history, when dividends fell approximately 25% from September 30, 2008, to March 31, Can this dividend growth number stay high, or is it likely to be a one-off event that eventually heads lower? A number of structural reasons lead us to believe the trends are going to continue over the medium to longer run, and they have to do with a change in how companies are distributing cash to their shareholders. FIGURE 2: 10-YEAR DIVIDEND GROWTH CHART 12.00% 10.00% Dividend Growth Percentage 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% -6.00% 10-Year Dividend Growth 20-Year Median Full-Period Median 6.92% 5.09% 3.96% -8.00% 1/31/1881 1/31/1886 1/31/1891 1/31/1896 1/31/1901 1/31/1906 1/31/1911 1/31/1916 1/31/1921 1/31/1926 1/31/1931 1/31/1936 1/31/1941 1/31/1946 1/31/1951 1/31/1956 1/31/1961 1/31/1966 1/31/1971 1/31/1976 1/31/1981 1/31/1986 1/31/1991 1/31/1996 1/31/2001 1/31/2006 1/31/ /31/2016 Sources: WisdomTree, Robert Shiller, 1/31/ /31/2015. Past performance is not indicative of future results. You cannot invest directly in an index. Companies historically have paid out a large majority of their earnings as dividends. From 1871 to 2015, the average dividend yield was 4.39%, and the average dividend payout ratio 12 was more than 60%. This is strikingly different from the average dividend yield of 2.07% and payout ratio of 37% over the most recent 10 years. 12 Dividend payout ratio: The percentage of earnings paid to shareholders in dividends. 3

4 FIGURE 3: DIVIDEND AND EARNINGS GROWTH Date Ranges Real Dividend Growth Nominal Dividend Growth Average Dividend Yield Average Dividend Payout Ratio % 3.61% 4.39% 60.15% % 1.25% 5.31% 70.81% % 6.15% 3.40% 48.60% % 6.92% 2.07% 37.37% Sources: WisdomTree, Robert Shiller, 1/31/ /31/2015. Past performance is not indicative of future results. You cannot invest directly in an index. Real dividend growth refers to the rate of dividend growth after inflation. Nominal dividend growth refers to the rate of dividend growth before inflation. Looking at just the current dividend yield of 2.07% could imply that the market is expensive because it is below the average 4.4% dividend yield of the markets since This might be the case if firms were not altering the way they return money to shareholders (i.e., through increased buybacks). Looking at the combined dividend yield and net buyback yield 13, or shareholder yield, might tell a different story about valuations. Whether these lower dividend payout ratios (higher retained earnings 14 or higher buybacks) are wasted or in fact lead to higher earnings and dividend growth is key to the debate about future returns on the market. The evidence says that over long periods, a decreased dividend payout ratio has led to increased earnings and dividend growth. Prior to 1946, the average payout ratio was more than 70% and dividend yields averaged 5.3%, but real (after-inflation 15 ) dividend growth was only 0.74%. After 1946, when the payout ratio decreased from more than 70% to less than 50% leading to a reduction in the average dividend yield to 3.4% real dividend growth increased to 2.3%, a pickup of 1.6%. 16 Looking at the history of the S&P 500 Index over the last 15 years, firms increasingly have been using share buybacks as a method for returning cash to shareholders: + As of December 31, 1999, dividends and share buybacks were roughly equal, at around $140 billion each. + But as of December 31, 2015, firms distributed to shareholders $572 billion of gross share buybacks and $382 billion of dividends over the previous 12 months. 17 But not all buybacks should be counted the same. Some companies buy back stock only to offset the dilution of shares that results from share issuance. What has an impact on future earnings and dividend growth are the buybacks that reduce total shares outstanding, as these buybacks impact per-share earnings and dividend distributions in the future, assuming a constant level of aggregate dividends being distributed or earnings generated. 13 Net buyback yield: A company s net share buyback takes both the issuance of any new shares and the buyback of any outstanding shares into account. A positive net share buyback means that more was spent on buying back existing shares than on issuing new shares. Net buyback yield is the amount of a company s net buybacks divided by its market capitalization. Please note that net buyback yield does not represent a dividend paid by the company. 14 Retained earnings: Portion of earnings that is not paid as dividends but held by the company for future investment opportunities. 15 Inflation: Characterized by rising price levels. 16 Note: Since there was a structural shift down in dividend payout ratio, it is not surprising the real dividend growth is greater than the reduction in dividend yield. 17 Source: Standard & Poor s, 12/31/15. 4

5 WisdomTree has an earnings-weighted Index of the U.S. markets, called the WisdomTree Earnings Index (), that covers more than 2,000 stocks and provides a good cross-section of the capital allocation plans of companies in the U.S. WisdomTree has been tracking the performance and fundamentals 18 of these profitable companies since early 2007, the Index inception. FIGURE 4: WISDOMTREE EARNINGS INDEX BUYBACKS $800 Buybacks ($B) $700 $600 $500 $400 $300 $200 $100 $521 $350 $667 $467 $482 $307 $205 Net Buybacks Gross Buybacks $370 $177 $476 $317 $417 $268 $516 $352 $622 $627 $446 $448 $0 $-100 -$95 -$200 2/28/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/2015 Sources: WisdomTree, FactSet, 2/28/07 12/31/15. Start date was chosen because it is first month-end after inception date of the WisdomTree Earnings Index (2/1/07). The unmistakable conclusion from the last few years of stock buyback data is that buybacks are having an impact on reducing shares outstanding. Impressively, since the calendar-year bottom in 2009, buybacks have tripled from $205 billion to $627 billion, and net buybacks have increased by more than $540 billion. Since Index inception, total gross buybacks have grown from $521 billion to $627 billion, and net buybacks have grown from $350 billion to $448 billion. As of December 31, 2015, only 14% of the WisdomTree Earnings Index s weight was in companies that increased shares outstanding over the previous 12 months; the other 86% either reduced shares outstanding or kept them constant. Over the last five years, on average, around 74% of the Index weight was in companies that had a positive net buyback yield (or reduced shares outstanding). Even more impressive, over the same period, around 47% of the Index weight was in companies that reduced shares outstanding by 2% or more. 18 Fundamentals: Attributes related to a company s actual operations and production as opposed to changes in share price. 5

6 THE FUNDAMENTAL DIFFERENCE: EARNINGS WEIGHTED VS. CAP WEIGHTED At WisdomTree, we believe that screening and weighting equity markets based on fundamentals such as dividends or earnings can help produce higher total and risk-adjusted returns 19 over a complete market cycle. One of the most important elements of a fundamental index is the annual rebalance process, where the index screens the eligible universe and then weights those securities based on their fundamentals. In essence, the process takes a detailed look at the relationship between the underlying fundamentals and price performance. Going back to the WisdomTree Earnings Index, weighting by Earnings Stream 20 is essentially tilting weight from a market cap-weighted scheme to over-weight those companies with below-average P/E ratios (lower priced) and to under-weight those companies with high P/E ratios (higher priced). The Earnings Stream can be defined as earnings per share times shares outstanding or market cap times earnings yield (which is equivalent to 1/PE ratio) 21. One way to illustrate the benefits of this approach for our earnings-weighted family is to compare the net buyback yield of the WisdomTree Earnings Index to a market cap-weighted peer universe, and contrast that with the net buyback yield on the highest- P/E-ratio stocks. Below we look at how the net buyback yield changes when U.S. equity markets are screened and weighted by a firm s profitability instead of its market cap. FIGURE 5: EARNINGS WEIGHTED VS. MARKET CAP WEIGHTING 6.00% 4.00% 2.00% 3.04% 1.73% 0.00% -0.32% Net Buyback Yield -2.00% -4.00% -6.00% -8.00% WisdomTree Earnings Index Cap Stocks High-Priced (P/E) Cap Stocks % Name Net Buyback Yield Average % % % WisdomTree Earnings Index 2.2% Cap Stocks 1.1% High-Priced (P/E) Cap Stocks -1.6% Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Mar-16 Sources: WisdomTree, FactSet, 2/28/07 3/31/16. Start date was chosen because it is first month-end after inception date for the WisdomTree Earnings Index (2/1/07). Cap Stocks represents the 3,000 largest U.S.-listed and -domiciled securities by market cap, weighted by market cap and reconstituted monthly. High-Priced (P/E) Cap Stocks refers to the 50% highest-priced stocks from a P/E perspective from the broad market cap universe. Net buyback yield does not measure dividends or investment returns from stocks and is not intended to represent the past or future performance of any particular index or investment product. Historical results do not guarantee future results. 19 Risk-adjusted returns: Returns measured in relation to their own variability. 20 Earnings Stream: Earnings per share x the number of shares outstanding. For an index, these totals are added for all constituents. 21 Earnings yield: Earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (which is the inverse of the P/E ratio) shows the percentage of each dollar invested in the stock that was earned by the company. 6

7 The WisdomTree Earnings Index consistently had a higher net buyback ratio compared to a hypothetical market cap index consisting of the 3,000 largest securities by market cap and the highest-priced subset of that universe. The WisdomTree Earnings Index averaged a net buyback yield of 2.2% over the period, compared to just 1.1% for the broad market cap stock universe and -1.6% for the highest-priced stocks. If corporate America responds well to incentives, the higher-priced basket would issue more shares (given that its stocks are high priced and issuing more of them would be an effective way to raise growth capital) and the lower-priced basket would issue fewer shares or buy back shares to reduce shares outstanding and thus power earnings-per-share growth. What we see in the data is that the higher-priced universe buys back fewer shares and instead issues more shares (having more companies with negative net buyback yields). We believe that having an annual profitability screen for inclusion in the WisdomTree Earnings Index avoids speculative and unprofitable smaller-capitalization firms that have a tendency to raise capital by periodically issuing new shares. Small-cap companies are almost constantly issuing shares to fund their growth, much more than large-cap companies. In the U.S., large-cap companies have been displaying fairly consistent 2% net buyback yields in recent years, compared to -2% for small-cap companies. 22 In small caps, there also tends to be a larger difference in the buyback yields of companies with high valuations (either companies losing money and needing to raise capital to fund their existence or companies selling at high price-to-earnings [P/E] ratios) compared to profitable companies and lower-priced companies. FIGURE 6: EARNINGS WEIGHTED VS. MARKET CAP WEIGHTING 4.00% WisdomTree SmallCap Earnings Index Small-Cap Stocks High-Priced (P/E) Small-Cap Stocks Name Net Buyback Yield Average WisdomTree SmallCap Earnings Index 0.3% Small Cap Stocks -2.1% 2.00% High-Priced (P/E) Small Cap Stocks -5.0% 1.16% Net Buyback Yield 0.00% -2.00% -4.00% -2.13% -6.00% -5.92% -8.00% Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Mar-16 Sources: WisdomTree, FactSet, 2/28/07 3/31/16. Start date was chosen based on first month-end after inception date of the WisdomTree SmallCap Earnings Index (2/1/07). Small-Cap Stocks represents the bottom 2,000 securities by market cap, from a universe of the 3,000 largest U.S.-listed and -domiciled by market cap, weighted by market cap and reconstituted monthly. High-Priced (P/E) Small-Cap Stocks represents the highest 50% of stocks by P/E ratios from the small-cap universe defined above. 22 Sources: WisdomTree, FactSet, 3/31/11 3/31/16. 7

8 The net issuance that happens in the small-cap, expensive-stock universe is one of the reasons we believe the small-cap growth category has a tough time outperforming the small-cap value category over time. Small-cap growth has been a fairly poor-performing long-run asset class, and over the last 50 years, small-cap value has outperformed small-cap growth by 7.6% per year. 23 Companies that are constantly issuing shares have to achieve a higher growth rate to overcome the dilution from raising shares outstanding. SHAREHOLDER YIELD: NET BUYBACK PLUS DIVIDENDS We believe the summation of current dividend yield and net buyback yields can be viewed as an important indicator for long-term return potential. The reason: An investor does not need to assume there is any real growth on top of those two sources of returns. A few interesting benchmarks: The S&P 500 Index had a combined dividend and net buyback yield of 4.36%, 24 right in line with the long-term average of 4.4%. When we look at a large-cap universe of stocks over the last 15 years, it has averaged a combined dividend and net buyback yield of 3.1%, so current readings are attractive compared to more recent history. 25 Assuming no growth and no change in valuations going forward, an investor could expect to earn (on a real, after-inflation basis) the combined dividend and net buyback yield, currently higher than the zero some prognosticators are predicting. FIGURE 7: EARNINGS WEIGHTED VS. MARKET CAP WEIGHTING 8.00% 7.03% Shareholder Yield 6.00% 4.00% 2.00% 0.00% 5.37% 4.07% 4.19% 3.41% 2.43% 1.96% 1.64% 2.84% 4.76% 1.90% 2.86% 1.52% 2.07% -0.55% 1.95% 4.94% 4.59% 3.93% 3.97% 4.19% 3.89% 3.38% 3.54% 3.22% 3.09% 3.20% 2.85% 2.45% 2.63% 2.04% 1.93% 2.10% 2.30% 1.54% 1.33% 1.61% 1.41% 1.49% 0.85% 1.84% 1.60% 1.96% 1.85% 2.00% 1.89% 1.87% 1.68% 1.89% 1.71% 2.09% 1.93% -2.00% -4.00% Dividend Yield Net Buyback Yield -3.81% -1.86% Name Average Monthly Shareholder Yield WisdomTree Earnings Index 4.2% Cap Stocks 2.9% -6.00% 12/31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/2015 Sources: WisdomTree, FactSet, 12/31/07 12/31/15. Start date was chosen because it is first year-end after inception date of the WisdomTree Earnings Index (2/1/07). refers to the WisdomTree Earnings Index. represents the 3,000 largest U.S.-listed and -domiciled securities by market cap, weighted by market cap and reconstituted monthly. 23 Source: Fama & French, 3/31/1966 3/31/2016. The portfolios, which are constructed at the end of each June, are the intersections of two portfolios formed on size (market equity, ME) and three portfolios formed on the ratio of book equity to market equity (BE/ME). Small-cap value would be the smallest 50% by ME and the highest 30% by BE/ME. Small-cap growth would be the smallest 50% by ME and the lowest 30% by BE/ME. 24 Sources: WisdomTree, Standard & Poor s, as of 3/31/ Sources: WisdomTree, FactSet, 3/31/01 3/31/16. 8

9 The shareholder yield for the WisdomTree Earnings Index has consistently increased over the past few years, signaling that the broad market has actually gotten less expensive by this metric. Also, if an investor agrees that firms are returning cash to shareholders differently than in the past, then the latest reading of 5.15%, as of March 31, 2016 which is higher than the long-term dividend yield of 4.4% for the S&P 500 Index could be used to defend current valuations of this Index. It is important to note that the WisdomTree Earnings 500 Index, which selects the 500 largest profitable companies from the WisdomTree Earnings Index, had a shareholder yield of 5.40%. 26 Below we look at a cross-section of WisdomTree Indexes, to illustrate how screenings and weighting by other fundamentals can also influence and increase shareholder yield, compared to market cap approaches. FIGURE 8: WISDOMTREE INDEXES SHAREHOLDER YIELDS Ticker Name Net Buyback Ratio Trailing 12M Dividend Yield Shareholder Yield (Net Buyback + Dividend Yield) WTDXF WisdomTree Dividend ex-financials Index 2.27% 3.94% 6.21% WTDGI WisdomTree U.S. Quality Dividend Growth Index 3.52% 2.40% 5.92% WTEPS WisdomTree Earnings 500 Index 3.23% 2.17% 5.40% WTLVI WisdomTree LargeCap Value Index 3.58% 1.59% 5.18% WisdomTree Earnings Index 3.04% 2.12% 5.15% WTLDI WisdomTree LargeCap Dividend Index 2.07% 3.08% 5.15% WTSDG WisdomTree U.S. SmallCap Quality Dividend Growth Index 2.37% 2.59% 4.96% WTDI WisdomTree Dividend Index 1.66% 3.16% 4.82% WTHYE WisdomTree High Dividend Index 0.37% 4.06% 4.43% N/A Large-Cap Stocks - Cap Weighted 2.17% 2.06% 4.23% N/A Cap Stocks - Cap Weighted 1.73% 1.97% 3.70% WTMEI WisdomTree MidCap Earnings Index 1.94% 1.69% 3.63% WTMDI WisdomTree MidCap Dividend Index 0.41% 3.16% 3.57% WTSEI WisdomTree SmallCap Earnings Index 1.16% 1.59% 2.75% WTSDI WisdomTree SmallCap Dividend Index -1.18% 3.86% 2.68% N/A Small-Cap Stocks - Cap Weighted -2.13% 1.40% -0.72% Sources: WisdomTree, FactSet, 3/31/16. Cap Stocks Cap Weighted represents the 3,000 largest U.S.-listed and -domiciled securities by market cap, weighted by market cap and reconstituted monthly. Large Cap Stocks Cap Weighted represents the largest 500 securities by market cap, from a universe of the 3,000 largest U.S.-listed and -domiciled by market cap, weighted by market cap and reconstituted monthly. Small Cap Stocks Cap Weighted represents the bottom 2,000 securities by market cap, from a universe of the 3,000 largest U.S.-listed and -domiciled by market cap, weighted by market cap and reconstituted monthly. Previously, we spoke about how screening based on profitability indirectly tilted the Index toward higher-quality firms, ultimately leading to higher net buybacks compared to market cap indexes. Both the WisdomTree U.S. Quality Dividend Growth Index (WTDGI) and the WisdomTree U.S. SmallCap Quality Dividend Growth Index (WTSDG) specifically target firms with high profitability metrics (based on both return on equity and return on assets), and these Indexes also have some of the highest net buyback yields above. 26 The WisdomTree Earnings Index is a broader index that includes mid- and small-cap companies, which biases down the net buyback yield for the Index. 9

10 This effect can be further illustrated by looking at a cross-section of our small-cap Indexes. WTSDG s net buyback ratio is more than 2.3%, while the broader WisdomTree SmallCap Dividend Index (WTSDI), which doesn t screen based on quality, had a negative buyback ratio (signaling stocks in the Index were net share issuers). It is also interesting to note that the WisdomTree SmallCap Earnings Index (WTSEI), a broad small-cap Index that screens for profitable companies (i.e., an indirect measure of quality), had a buyback ratio that was more than 2% higher than WTSDI. WTSDG is a quality subset of the small-cap market, but looking at total shareholder yield of just the broad-based fundamental small-cap Indexes, WTSEI and WTSDI, also tells an interesting story. WTSEI and WTSDI had similar shareholder yields of 2.75% and 2.68%, respectively, but the makeup of those yields was quite different. Although WTSDI had a net buyback yield that was 2% lower than WTSEI, the over 2% higher dividend yield for WTSDI made up almost the entire difference. Also impressive was that both Indexes had a total shareholder yield of more than 3.4% higher than a small-cap stock peer group, which had a negative net shareholder yield, and the share issuance did not surpass the actual dividend yields. CONCLUSION An investor can look at the share buyback plans of corporate America and conclude that firms are not confident in their businesses and lack immediate investment opportunities. Alternatively, an investor can look at the buybacks as locking in a certain level of earnings growth in the future because firms are confident in their current set of cash flows and organic growth rates of their businesses. Reducing shares outstanding can be an effective way of powering up future per-share growth. Those who assume that future dividend growth is going to mean revert and trend back to historical levels thus claiming the market is expensive given its below-average dividend yields are not accounting for the net buybacks, which are locking in some future dividend growth. While corporations certainly may not always time the buybacks correctly buybacks tend to decrease during market declines and increase during growth periods the net share-count reduction trends we are seeing should be very encouraging support for valuation levels of the market. 10

11 Dividends are not guaranteed, and a company s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time. Investors should carefully consider the investment objectives, risks, charges and expenses of the Fund before investing. To obtain a prospectus containing this and other important information, please call WISE (9473) or visit wisdomtree. com. Investors should read the prospectus carefully before investing. There are risks associated with investing, including possible loss of principal. Investments focusing on certain sectors and/or smaller companies may be more vulnerable to any single economic or regulatory development. This may result in greater share price volatility. As investments can have a high concentration in some issuers, they can be adversely impacted by changes affecting those issuers. Please read the Fund s prospectus for specific details regarding the Fund s. S&P 500 Index: A market capitalization-weighted benchmark of 500 stocks selected by the Standard & Poor s Index Committee, designed to represent the performance of the leading industries in the United States economy. WisdomTree Earnings Index: A fundamentally weighted index that measures the performance of earnings-generating companies in the broad U.S. stock market. WisdomTree Earnings 500 Index: A fundamentally weighted index that measures the performance of earnings-generating companies in the large-capitalization segment of the U.S. stock market. Companies in the Index are incorporated and listed in the U.S. and have generated positive cumulative earnings over their most recent four fiscal quarters prior to the index measurement date. The index comprises the 500 largest companies ranked by market capitalization in the WisdomTree Earnings Index. WisdomTree MidCap Earnings Index: A fundamentally weighted index that measures the performance of the top 75% of the market capitalization of the WisdomTree Earnings Index after the 500 largest companies have been removed. WisdomTree SmallCap Earnings Index: A fundamentally weighted index that measures the performance of earnings-generating companies in the small-capitalization segment of the U.S. stock market. The Index comprises the companies in the bottom 25% of the market capitalization of the WisdomTree Earnings Index after the 500 largest companies have been removed. WisdomTree Dividend Index: Measures the performance of dividend-paying companies incorporated in the United States that pay regular cash dividends and meet WisdomTree s eligibility requirements; weighted by indicated cash dividends. WisdomTree LargeCap Dividend Index: A fundamentally weighted index that measures the performance of the large-capitalization segment of the U.S. dividend-paying market. The Index comprises the 300 largest companies ranked by market capitalization from the WisdomTree Dividend Index. WisdomTree MidCap Dividend Index: A fundamentally weighted index that measures the performance of the mid-capitalization segment of the U.S. dividend-paying market. The Index comprises the companies that constitute the top 75% of the market capitalization of the WisdomTree Dividend Index after the 300 largest companies have been removed. The Index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividends per share. WisdomTree SmallCap Dividend Index: A fundamentally weighted index that measures the performance of the small-capitalization segment of the U.S. dividend-paying market. The Index comprises the companies that constitute the bottom 25% of the market capitalization of the WisdomTree Dividend Index after the 300 largest companies have been removed. The Index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividends per share. WisdomTree High Dividend Index: Measures the performance of the 30% highest-yielding dividend-paying equities in the WisdomTree Dividend Index; weighted by indicated cash dividends. WisdomTree Dividend ex-financials Index: Measures the performance of high-dividend-yielding stocks outside the Financials sector. The Index consists primarily of large- and mid-capitalization companies listed on major U.S. stock exchanges. Weighting is by dividend yield. WisdomTree U.S. Quality Dividend Growth Index: A fundamentally weighted index designed to track the performance of dividend-paying companies in the U.S. that WisdomTree believes have the potential to increase their dividends due to certain factors, which include estimated earnings growth, return on equity and return on assets. Weighting is by indicated cash dividends. WisdomTree U.S. SmallCap Quality Dividend Growth Index: A fundamentally weighted index designed to track the performance of dividend-paying companies in the U.S. small-cap equity universe that WisdomTree believes have the potential to increase their dividends due to certain factors, which include estimated earnings growth, return on equity and return on assets. Weighting is by indicated cash dividends. WisdomTree LargeCap Value Index: A fundamentally weighted index that measures the performance of large-cap value companies. The Index consists of U.S. companies that have positive cumulative earnings over the past four fiscal quarters and that meet WisdomTree s requirements as of the Index measurement date. WisdomTree creates a value score for each company based on the company s price-to-earnings ratio, price-to-sales ratio, price-to-book value and one-year change in stock price. After selecting the 1,000 largest market capitalization securities that pass the initial selection requirements, the bottom 10% based on the one-year change in stock price are excluded, and the top 300 companies ranked by their combined value score are selected for inclusion. Companies are weighted in the Index annually based on earnings. WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only. Jeremy Schwartz, Tripp Zimmerman and Josh Russell are registered representatives of Foreside Fund Services, LLC WisdomTree Investments, Inc. WisdomTree is a registered mark of WisdomTree Investments, Inc. WTGM