With Dividend Durability in Focus, Lean on This ETF | ETF Trends

The outlook for shareholder rewards, including buybacks and dividends, is growing murky this year. Many companies are scuttling repurchase plans and any firm approaching the federal government for financial assistance has to scrap buybacks and limit or eliminate dividends.

Some companies, including several in the energy and energy sectors, are already slashing payouts. Those ominous scenarios put added emphasis on dependable, durable dividends, which are accessible via ETFs such as 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.

Part of DURA’s “secret sauce” is what’s known as the distance to the default score.

“Distance to Default is a measure of financial health that considers a company’s balance sheet strength and equity market data to assess the likelihood of bankruptcy,” said VanEck in a recent note. “Distance to Default has proven to be an effective predictor of dividend cuts: those companies with the lowest probability of default have had the lowest probability of future dividend cuts, according to Morningstar.”

Depending on DURA

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.

“Amid the crisis, falling stock prices have sent dividend yields soaring, but many companies may be forced to suspend or even trim dividends to preserve cash,” according to VanEck. “Investors who focus only on the highest yielding stocks or rely on backward-looking statistics may find themselves holding shares of troubled companies that go on to cut or suspend their dividends and suffer painful share-price declines.”

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 a company’s financial distress, which may oftentimes appear before it is reflected in financial statements.

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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.