Dividend stocks and ETFs had seen a lot of interest in the past 2-3 years as investors searched for yield in the ultra-low interest environment. However they have been out of favor of late, since the taper talk has resulted in interest rates inching higher. Further, many sectors that are high dividend payers—like utilities, telecom, and staples—had become rather expensive and were punished by investors worried about the rate increase.
Is Dividend Investing Dead?
Even though dividend stocks and ETFs have been experiencing some headwinds in the face of taper talk, they should remain a part of any investment portfolio focused on the long term. Dividends have accounted for more than 40% of total returns from the market over a long time horizon (over the past 80 years). (Read: 3 ETFs for Rising Interest Rates)
Per S&P, dividend net increases (increases less decreases) rose $17.6 billion during Q2 2013, as 591 dividend increases were reported during the quarter, up 17% from 505 dividend increases reported during Q2 2012.
The trend is expected to continue in the coming months as most large companies have huge cash piles on their balance sheet and are in a position to increase payouts to shareholders.
Further due to the muddle-through growth environment, many companies continue to avoid large scale capital expenditure and M&A activities and rather prefer to return excess cash to shareholder by way of dividends and buy backs. (Read: Best ETFs from the market’s top sector)
In my view, ETFs that hold stocks with a high dividend growth potential are much better for long-term investing than ETFs that focus on high dividend yielding stocks.
How do Investors Reposition their Dividend Portfolios?
ETFs that have high exposure to utilities, telecom and REITs, will likely remain out of favor with investors, amid rising interest rates and worries about the Fed’s plans for scaling down its bond-buying program. It is time investors should focus on the new dividend growth leaders-mainly technology and finance.
According to Markit, S&P 500 dividends in 2H13 will be up 13% from last year, with Technology sector leading in terms of change from last year, followed by Oil & Gas and Banks. Markit dividend model currently ranks Insurance, Banks and Technology sectors as most favorable.
During the last five years, technology sector has accounted for more than 54% of the increase in dividends and financials have accounted for the largest increase in last three years, per WisdomTree. (Read: 3 ETFs for Manufacturing Renaissance)
Below we have analyzed three ETFs that have excellent dividend growth potential.
Investors looking for dividend growth opportunities while staying diversified across sectors could consider the new product from WisdomTree that has a has forward-looking dividend growth focus.
The index uses both growth and quality factors with the growth factor ranking based on long-term earnings growth expectations and the quality factor ranking based on three year historical averages for return on equity and return on assets.
Further, the Index is dividend weighted to reflect the proportionate share of the cash dividends each component company is expected to pay in the coming year. The fund has a 30 day yield of 2.01% as of now.
Apple, Microsoft, P&G, Wal-Mart and Coca-Cola are the top five holdings as of now. Among the sectors—the fund has highest allocation to Technology, Industrials and Consumer Discretionary sectors. It has an expense ratio of 28 basis points.
Many companies in this sector already pay out very attractive dividends; tech giants like Intel, Cisco, Microsoft and Apple, have dividend yields higher than the S&P 500 index. And many of them double-digit earnings growth potential once the economy picks up steam.
Investors could consider TDIV, which seeks to focus on dividend payers within the technology sector. For being included in the index, apart from meeting minimum market cap and liquidity requirement, the security should have paid a dividend and not decreased its dividend within the past 12 months.
The index employs a modified dividend value weighting methodology and the current top holdings of the fund are Microsoft, Intel, Cisco, IBM and Apple. The ETF has a dividend yield of 2.16% currently and charges an expense ratio of 50 basis points.
Vanguard Dividend Appreciation ETF (VIG)
VIG holds stocks of high quality companies that have a record of increasing dividends for at least 10 years. Launched in April 2006, the fund is now the largest dividend ETF, with $19.1 billion in AUM. With its high quality holdings and focus on dividend growth, this ETF has been an excellent performer in the past and will most likely continue to outperform.
The fund is currently home to 143 securities, with top allocations to Pepsi, Coke and P&G. The ETF is heavily weighted towards Consumer Goods (24%), Industrials (21%) and Consumer Services (17%) sectors.
While the fund doesn’t have a large exposure to Financials (8%) and Technology (5%) sectors as of now, it is likely to benefit from its high exposure to consumer related and industrials sectors in view of their brightening outlook. Further it has very low allocations to utilities (1%) and telecom (0.1%) sectors.
With an expense ratio of 0.10%, this is one of the cheapest funds in this space. The dividend yield at 2.06% is not remarkable, but this fund is better suited for investors who seek long-term capital appreciation along with income and not just high current yield.