Historically, dividend stocks have been durable and less bad during market swoons. While the latest retrenchment in equities is testing that thesis, some dividend strategies merit consideration, including the VanEck Vectors Morningstar Durable Dividend ETF (DURA).
DURA seeks to provide exposure to high dividend-yielding U.S. companies with strong financial health and attractive valuations, according to Morningstar. DURA seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Morningstar® US Dividend Valuation IndexSM. The Index leverages Morningstar’s forward-looking fair value assessments as well as its proprietary quantitative Distance to Default score, which helps target financially strong companies with a higher probability of sustaining dividend payments.
An important element of DURA is that it helps investors dangerous high yield plays and dividend traps that could be vulnerable to dividend cuts or suspensions.
“The term dividend trap refers to a company that lures investors with impressive, but ultimately unsustainable payouts,” said VanEck in a recent note. “Dividends are not guaranteed and even long-time dividend-paying companies are susceptible to reducing or cutting their dividends altogether. Unhealthy companies put an investor’s income stream and principal at risk. Financial distress can lead to dividend cuts or suspensions, share price depreciation and bankruptcy.”
Depending on DURA
DURA has a 30-day SEC yield of 3.23%, or more than triple what investors find on 10-year Treasuries and the fund has some defensive positioning by allocating over a quarter of its weight to healthcare stocks. Importantly, that yield isn’t so as to be a cause for alarm.
“Additionally, overpaying for yield has become a serious concern,” said VanEck. “A decade’s worth of steady investor flow to dividend-paying stocks paired with U.S. equity markets reaching all-time highs make valuation considerations particularly important. Current valuations do not provide much of a cushion for disappointment, but higher multiples and lower discount rates are not inconsistent with a low growth environment. Buying into stock positions at inflated prices can destroy returns when they revert back to fair value.”
With traditional dividend-paying stock strategies, investors may be exposed to unintended risks. For instance, high dividend-yielding companies may be exposed to some perceived risk with an equity investment in that company. For consistent dividend payers or dividend growers, investors are relying on historical patterns to repeat themselves in the future, and as we all know, past performance is no guarantee of future results.
“Companies in businesses with secular growth drivers that have clear competitive advantages, low leverage and strong management teams are better equipped to maintainable profit over time—even in a tougher macroeconomic and market environment,” notes VanEck. “Carefully selecting dividend-paying companies based on their dividend yields coupled with an assessment of their fair value and balance sheet strength may allow for a portfolio with more potential upside (capital appreciation) while still maintaining an attractive dividend yield (income stream).”
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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.