How to Play Defense, Access Quality With Dividends | ETF Trends

Dividend stocks are thought to be defensive, but that reputation is under attack this year amid a spate of S&P 500 dividend cuts. Focusing on quality with ETFs, including the FlexShares Quality Dividend Defensive Index Fund (NYSEArca: QDEF) can help investors avoid some of the payout offenders.

QDEF offers dividend growth potential and security due to FlexShares’ proprietary dividend quality scoring methodology.

The Dividend Quality Score process is designed to maximize quality and yield while putting several diversification controls into effect through its selection and weighting process. FlexShares’ multi-faceted dividend quality score examines companies based on three factors when determining their dividend quality indexing methodology.

ETFs have gravitated toward low-cost, pure beta investments for years, but many are beginning to warm up to smart beta or factor-based strategies that aim to enhance returns and limit downside risks.

QDEF Is Right For This Environment

With so many S&P 500 companies paring payouts this year, it’s evident that high dividend strategies aren’t always defensive and can expose investors to negative dividend action. The opposite is true of QDEF.

There are flaws in dividend-focused strategies. For instance, reacting to a reduced dividend after the fact results in holding the dividend-paying security until the next rebalance or potentially after the stock price has reacted to the news. To evaluate consistent dividend payers, a long history is required, which means newer players are excluded from consideration. Short-term changes in the macro-environment could affect a company’s ability to maintain or grow dividends.

Alternatively, FlexShares argued that focusing on the core financial health of a dividend-paying company may be a better approach to address some of the shortcomings of other dividend-themed strategies.

By using a management efficiency screen, the index can screen out firms that aggressively pursue capital expenditures and additional financing, which typically lose flexibility in both advantageous and challenging partitions of the market cycle.

A profitability score is also taken based on a firm’s relative competitive advantage across several metrics. Firms with wider margins typically are better positioned to expand compared to those with tighter margins.

Lastly, cash flow provides a better understanding of liquidity levels for a company. A firm that does not meet its debt obligations and day-to-day liquidity needs are likely to be poorly positioned to take advantage of future opportunities or have a financial cushion during downturns.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.