How to Buy Dividend Growth Stocks

Clients looking to acquire dividend-oriented equity funds must navigate a number of portfolio options -- and a related set of challenges.

State Street Global Advisors recently counted 44 U.S. ETFs that employ dividend strategies. Understanding how they differ isn’t always easy; the dividend strategy may not be obvious from the fund’s name, and products based on similarly named underlying indexes can be very different.

You might think, for instance, that the WisdomTree U.S. Dividend Growth Fund (DGRW) invests in stocks with increasing dividends. But WisdomTree’s description of the underlying index says that it “consists of dividend-paying stocks with growth characteristics.” Dividend growth isn’t actually a requirement: “The growth factor ranking is based on long-term earnings growth expectations,” the company notes.

A handful of ETFs do in fact stress dividend growth. Most are based on a pair of competing decades-old stock market screens -- "Dividend Aristocrats," from Standard & Poor's, and "Dividend Achievers," from Moody's -- both of which eventually morphed into indexes to serve the burgeoning ETF market.

DIVIDEND ARISTOCRATS

Let's start with S&P’s Dividend Aristocrats list, which identifies companies in the S&P 500 index that have raised their shareholder payments annually for 25 or more consecutive years.

Recent research confirms the value of stocks that increase dividends regularly. In a recent study, Bankrate.com compared $1 million portfolios of stocks and bonds, assuming that retirees withdrew an initial $40,000 and increased the amount by 3% annually.

The fixed-income portion of the portfolio was always the Barclays U.S. Aggregate Bond index. For the stock portion, the study compared three options: the S&P 500, the S&P 500 Dividend Aristocrats and a group of equity income funds that had 20-year records. The simulation tested both 60/40 and 40/60 splits, setting the start point at 1994. (In a separate test, the same splits and equity choices were used starting in 2000, a low year for stocks.)

In all cases, the study showed a higher ending value for the portfolios using the S&P 500 Dividend Aristocrats.

In July 2012, S&P’s index department became part of the joint venture S&P Dow Jones Indices -- which now publishes indexes, including the Aristocrats, under both the Standard & Poor’s and Dow Jones brands.

The Dividend Achievers list -- created in 1979 by S&P’s crosstown rival, Moody’s -- includes stocks with 10 or more years of higher dividend payments. Moody’s equities unit has since become a separate company called Mergent, which agreed to sell its index business to Nasdaq OMX Group in October 2012.

VARYING VERSIONS

Funds based on both lists vary in execution. For one thing, the two index providers have created foreign stock versions of their benchmarks with somewhat different methodologies than those used for domestic equities. And even within the U.S. stock market, there are permutations.

  • The most popular Dividend Aristocrats ETF, for instance, isn’t based on the S&P 500. The SPDR S&P Dividend ETF (SDY) has $12.5 billion in assets and tracks the S&P High Yield Dividend Aristocrats index. This benchmark is based on the broader S&P 1500 index and screens for companies with 20 years of dividend increases, rather than 25 years. 
  • Investors seeking exposure to the traditional S&P 500 Dividend Aristocrats, on the other hand, should seek out the ProShares S&P 500 Aristocrats ETF (NOBL), launched last October.
  • A version of the Dividend Achievers, meanwhile, underpins the hugely popular Vanguard Dividend Appreciation ETF (VIG). The fund tracks the Nasdaq U.S. Dividend Achievers Select index, a subset of Nasdaq's Broad Dividend Achievers index to which additional undisclosed “proprietary” criteria have been applied.
  • And one of the newer ETFs to carry the Achievers brand, the First Trust Nasdaq Rising Dividend Achievers Fund (RDVY), tracks stocks that pay higher dividends now than in the past. But because it uses an index that isn’t based on the Broad Dividend Achievers benchmark, it doesn’t require 10 consecutive years of increased payments.

Just as you can’t tell a book by its cover, you can’t tell a fund by its name. Because of these variations, advisors should look carefully at dividend growth fund options before choosing an investment.
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