Amid a spate of negative dividend action by S&P 500 members this year, dividend growth strategies, such as the SPDR S&P Dividend ETF (NYSEArca: SDY), are taking on increasing importance for income-starved investors.
SDY, one of the largest U.S. dividend ETFs, holds firms that have a minimum dividend increase streak of 20 years. Moreover, SDY follows a yield-weighting methodology that allocates a larger weight toward those with higher yields, so the portfolio leans toward more mid-sized companies. Historical data confirm that dividends are major contributors to investors’ long-term, total returns.
“Launched in 2005, the S&P High Yield Dividend Aristocrats Index comprises S&P Composite 1500® members that have increased their dividends annually for at least 20 years,” said S&P Dow Jones Indices in a recent note. “The market has rewarded consistent dividend payers. The High Yield Aristocrats have outperformed the S&P 1500 over the long term.”
Sizing Up SDY
Dividend-paying stocks can also help insulate investors from a broad market pullback. That’s particularly true of dividend growers, such as SDY components, which by virtue of their quality traits, tend to display less volatility in rough markets.
SDY components have some other traits that are important in today’s trying dividend environment.
“Earnings were double last year’s dividend payouts for the Aristocrats, vs. only 1.2x dividends for the high payers. Cash on hand was also a higher multiple of last year’s dividends,” according to S&P Dow Jones.
Investors receive higher returns on stocks than bonds from dividends alone, even without the potential for further upside in price gains. Alternatively, one may look to quality dividend-paying stocks that provide a steady income in volatile conditions.
“The Aristocrats used buybacks to return cash to shareholders to a greater degree than the high payers did. Since buybacks are likely to be reduced before dividends are cut, their usage provides a larger cushion for the Aristocrats,” notes S&P Dow Jones.
The Covid-19 pandemic should not be seen as the lone proving ground for SDY, but it does shine a light on the veracity of the strategy.
“There obviously can be no guarantees in a pandemic; if a company’s business is affected badly enough, dividend reductions are always possible regardless of how strong the income statement and balance sheet appeared a year ago,” according to S&P Dow Jones. “What this analysis tells us, though, is that the dividends of companies with consistent dividend growth are better protected from headwinds.”
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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.