Journal of Financial Planning: July 2016
Tom Lydon is editor of ETFtrends.com, and president of Global Trends Investments, a registered investment adviser. He is a frequent contributor to major print, radio, and television media.
The dividend investment theme is having its day in the sun as the value style gains momentum. With yield-generating ETFs in the limelight, investors may wish to focus on high-quality dividend growers that offer sustainable payouts.
Dividends are often seen as a reflection of confidence in a company’s balance sheet, earnings, and performance outlook. Consequently, cutting or suspending dividends could be a sign of potential weakness; it may signal cash flow or debt problems. Consistently dishing out dividends, however, is often seen as a sign of stability, reflecting management’s commitment to return cash to shareholders.
Dividend-paying companies that have consistently increased dividends are ranked among an elite group of dividend payers and have outperformed those that eschewed cash payouts. For instance, looking at Russell 3000 companies between 1987 and the end of 2015, dividend growth companies returned an average 13.4 percent, whereas other dividend payers returned 11.9 percent, non-paying companies returned 7.1 percent, and dividend cutters saw a 6.7 percent return.
Dividend growth stocks may outperform the broader equities market this year as a flagging bull market begins to peter out.
“We expect stocks with above-average dividend yield and growth will beat the flat S&P 500 return we predict over the next eight months,” Goldman Sachs analysts, led by chief U.S. equity strategist David Kostin, wrote in a recent note. “We prefer the combination of value, yield, and growth because yield-focused strategies may be at risk if the Fed decides to hike more than the market now expects.”
Moreover, stocks that appear to offer attractive yields may be forced to cut dividends in the future. And, high-yield dividend payers may be investing less in the growth of their business, which may drag on future earnings and stock returns. Advisers interested in quality dividend-paying stocks can track the group through targeted ETFs.
For example, the Vanguard Dividend Appreciation ETF (VIG) tracks U.S. stocks that have increased dividends on a regular basis for at least 10 consecutive years and has a 2.18 percent 12-month yield. The Schwab U.S. Dividend Equity ETF (SCHD) includes 100 stocks based on strong fundamentals, dividend yields, and consistent dividend payouts for at least 10 consecutive years, and it has a 2.97 percent 12-month yield. The SPDR S&P Dividend ETF (SDY) holds firms that have a minimum dividend increase streak of 20 years and shows a 2.93 percent 12-month yield. And the ProShares S&P 500 Aristocrats ETF (NOBL) only includes companies that have increased dividends for at least 25 consecutive years and offers a 1.92 percent 12-month yield.
The dividend growth strategy can also be applied to targeted small- and mid-cap asset categories.
For small- and mid-cap dividend ETF exposure, advisers can consider options like the WisdomTree U.S. SmallCap Dividend Growth Fund (DGRS), ProShares Russell 2000 Dividend Growers ETF (SMDV), and ProShares S&P MidCap 400 Dividend Aristocrats ETF (REGL).
DGRS includes growth and quality factors. Its underlying index ranks companies based on long-term earnings growth expectations, while the quality factor is based on three-year historical averages for return on equity and return on assets. The underlying index then weights holdings based on aggregate cash dividend expectations for the coming year. It has a 2.13 percent 12-month yield.
SMDV, a dividend spin on the Russell 2000, tracks the Russell 2000 Dividend Growth Index. This underlying index includes small-cap firms with dividend increase streaks of at least a decade. Index constituents are screened for liquidity and dividend status, then selected and equal weighted subject to a maximum sector weight of 30 percent. SMDV has a 1.72 percent 12-month yield.
And REGL tracks a dividend aristocrats index (and has a 1.56 percent 12-month yield). The midcap dividend aristocrats index, though, requires 15 consecutive years of increased dividends for inclusion.