As income-minded investors look into opportunities for income generation in a low-yield environment, many are considering a high-dividend exchange traded fund strategy that targets financially healthy companies with attractive valuations.
In the recent webcast, A Durable Dividends Strategy for a Low-Yield Environment, Dan Lefkovitz, Strategist, Morningstar Indexes, underscored the importance of a dividend-generating investment in a long-term portfolio.
“Dividend-paying stocks are an attractive way to participate in equities over the long term, not just for investors seeking income but also for total return,” Lefkovitz said.
As investors consider ways to access quality dividend-paying stocks, Lefkovitz argued that one should consider the distance to default to predict the likelihood of bankruptcy, which has also proven an effective predictor of dividend cuts. Factors like asset values and total liabilities reveal balance sheet information for the basis of default analysis. Equity volatility is also an important market data point because it can be a leading indicator of company’s financial distress, which may often times appear before it is reflected in financial statements.
At Morningstar, the indexer has created a model to predict the probability that asset values will fall below liabilities resulting in default. The methodology targets companies with higher distance to default scores or lower probability of default.
The goal is to create a forward-looking valuation indicator instead of relying on the trailing 12-month dividend yield that calculates historical data. Morningstar would take into consideration the fair value, an uncertainty rating and a star score. The Fair Value score is a three-stage discounted cash flow model used to determine the fair value estimate of a company based on future earnings potential. The Uncertainty Rating is determined by fair value scenarios used to determine the margin of safety required to recommend buying or selling of a stock. Lastly, the Star Score is a combination of a company’s price-to-fair value and uncertainty rating which adds buy/sell conviction to Morningstar’s fair value estimate
The result is the Morningstar US Dividend Valuation Index Screening Process, which includes the top 50 of eligible securities as measured by trailing 12-month dividend yield, the top most attractively priced as measured by Morningstar Star Score, and the top 50% of their peer group as measured by distance to default score.
Investors can gain exposure to this customized Morningstar dividend investment methodology through the VanEck Vectors Morningstar Durable Dividend ETF (DURA). Brandon Rakszawski, Director, ETF Product Development, VanEck Vectors ETFs, VanEck, argued that DURA can help investors access yields at a better value.
“Morningstar’s valuation estimate of companies incorporates an assessment of a company’s economic moat and a projection of the sustainability of its profit potential over time,” Rakszawski said. “Carefully selecting dividend paying companies based on dividend yield, financial health, and valuation may allow for a portfolio with more potential upside. Incorporating the valuation and financial health assessment offers a higher yield historically than U.S. dividend paying stocks broadly and the U.S. market as a whole and more attractive valuations.”
Financial advisors who are interested in learning more about a durable dividend strategy can watch the webcast here on demand.