With speculation high that the Federal Reserve could raise interest rates multiple times this year, the time is right for dividend investors to consider dividend growth stocks over high dividend names, which are usually more sensitive to changes in interest rates.
The iShares Core Dividend Growth ETF (NYSEArca: DGRO) is a solid idea among dividend growth exchange traded funds. Making DGRO all the more attractive is its paltry expense ratio of just 0.08% per year, or $8 on a $10,000 investment. BlackRock, the parent company of iShares, unveild a slew of fee cuts on iShares core ETFs in October, including DGRO.
DGRO specifically targets companies that pay a qualified dividend, must have at least five years of uninterrupted annual dividend growth and their earnings payout ratio must be less than 75%. While a rise in rates would diminish the attractiveness of dividend stocks with premium valuations and low growth, more high quality dividend payers or the group of dividend growers may stand out.
“DGRO tracks the Morningstar US Dividend Growth Index. To qualify for this index, a company must have established a 5-year history of increasing their dividend payments, display positive consensus earnings forecasts from the analyst community, and pay out no more than 75% of their earnings in dividends,” according to a Seeking Alpha analysis of the ETF.
One of that index’s mandates is that constituent firms have a minimum of five years of uninterrupted dividend growth. For example, the Morningstar US Dividend Growth Index does not include companies with yields that rank in the top 10% of the eligible inclusion universe and only companies with a payout ratio of less than 75% can be included, according to Morningstar.
Six sectors – financial services, consumer staples, industrials, technology, healthcare and consumer discretionary – command double-digit allocations in DGRO. Nine of the top 10 holdings in the ETF are members of the Dow Jones Industrial Average.
Additionally, dividend-paying stocks typically outperform those that do not pay over the long haul, with less volatility, due to the compounding effect of dividends on the investment’s overall return.
“Further, as a safety measure, stocks with an indicated dividend yield in the top 10% of the universe are eliminated. In many cases, when a company’s dividend reaches this level, it can indicate financial distress and/or a high likelihood of dividend cuts. Finally, all dividends must quality for preferential tax rates, thus no REITS are included. The index is reconstituted once per year and, at that time, no single constituent may carry more than a 3% weighting in the index,” adds Seeking Alpha.
For more information on dividend stocks, visit our dividend ETFs category.