Smart Beta Channel

Look to Dividend Grower ETFs to Generate Extra Cash

Government bond yields are still anemic throughout much of the developed world, highlighting the utility of dividend stocks and exchange traded funds in income investors’ portfolios. One idea to consider is the WisdomTree U.S. Quality Dividend Growth Fund (NASDAQ:DGRW).

Despite expectations for a tighter monetary policy out of the Federal Reserve and rising interest rate outlook, fixed-income yields remain stubbornly low. Consequently, income-starved investors may turn back to high-yield dividend exchange traded funds to generate a little extra cash.

DGRW includes companies with high long-term earnings-growth forecasts for the next three to five years and weights components based on the value of dividends they are expected to pay over the next year. The ETF tracks the WisdomTree U.S. Dividend Growth Index (WTDGI), which evaluates companies based on earnings quality, return on assets and return on equity.

“Return on equity is a very useful way to measure a company’s profitability. But ROE can be increased through excessive borrowing,” according to a Seeking Alpha analysis of the ETF. “In order to control this, DGRW also uses return on assets in its quality rankings, which would tend to penalize companies that use too much leverage. That way, the fund tends to own less risky stocks which have more consistent dividend-paying ability.”

Related: The 5 Best Performing ETFs of 2017

DGRW could be ideally positioned to endure higher interest rates, should the Federal Reserve opt to resume that trend later this year. 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.

The $1.63 billion DGRW, which is over four years old, allocates substantial portions of its weight to cyclical sectors that often perform well when rates rise. For example, ETF allocates over 56% of its combined weight to technology, industrial and consumer discretionary stocks.

“DGRW also use earnings growth expectations as a way to predict future dividend growth. This is a forward-looking approach which is quite different from many other dividend-based ETFs that look backward for long dividend increase streaks (e.g., Dividend Aristocrats). By relaxing the requirement of having to pay increasing dividends for many years, the fund is allowed to own some excellent growth companies that have not been around long enough to pay out 20 or 25 years’ worth of increasing dividends,” according to Seeking Alpha.

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Tom Lydon’s clients own shares of DGRW.

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