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The Dividend Yield Factor – A New Yaw on Higher Yields

Posted on: 02.09.2017

Introduced in 2003, dividend ETFs are a new vehicle for a well-tested equity performance metric – dividend yield. Dividends have long been recognized as a key driver of long-run stock returns.

Stock performance has been especially strong for the defensive duo of regular and increasing dividend payments. During low interest-rate environments, market volatility, and market downturns, investors in dividend ETFs can continue to receive a steady and reliable income stream. Here’s how:

Consistent dividend payout history – A 20-year history of steady dividend payments is the cut off for many dividend ETFs, though some will go as low as 10 years. The S&P Dividends Aristocrats index includes companies with a 25-year history of consistent dividend payments.

Rising dividend payments – Mostly large, financially stable companies meet the defensive duo criteria of increasing and regular dividend payments, owing to their steady revenue and earnings growth, and strong cash positions. Although dividend yield may be increased in response to either strong performance or under performance.  Apple consistently increases its dividend yield in line with its earnings growth. IBM’s falling stock price in response to volatile earnings, in contrast, has pushed its dividend yield up to 4%, among the highest on the Dow Jones index. Companies with a defensive policy of increasing and regular dividend payouts tend to experience lower stock price volatility in response to earnings volatility.

Some smart beta dividend ETFs do diversify across the safety spectrum of small to large cap stocks, with large cap providing the highest margin of safety. Small growth companies are more likely to experience revenue and earnings volatility, and thus inconsistent dividend payments. The smaller universe of small and medium cap stocks that do meet the criteria of regular and rising dividends, however, can provide excess returns.

Dividend ETFs with a tilt towards midcaps have done well in the current bull market (see table, ProShares S&P MidCap 400 Dividend Aristocrats and iShares Select Dividend). The IShares Select Dividend ETF uses a weighting by dividend per-share rather than market capitalization, which provides more exposure to small and mid-cap stocks. Also worth mentioning is the Oppenheimer Ultra Dividend Revenue ETF (RDIV), which tracks a midcap index, the S&P 900 index. The fund, which has a three-year return of 10.24, provides a yield a 4.9%.

The Dividend Premium

There are two components to the return of an investment that pays a dividend – the market return of the underlying security, and the dividend yield.

Dividend paying stocks have consistently outperformed the market on both a raw return and risk-adjusted basis. From 1927 to 2014, dividends rewarded investors with an annual average return of .7% above the market.  The top 30% of stocks by highest dividend yield returned an impressive 1.5 percent annually on average.

The high dividend yield advantage is evident in the high returns of the SPDR S&P Dividend ETF (SDY) (see table). SDY tracks the S&P High Yield Dividend Aristocrats Index to provide a yield premium on the broader but still market-beating S&P 500  Dividend Aristocrats Index,  with 3-year returns of 8.42 and 8.27, respectively.

Some would argue that dividend growth – the rate at which a dividend is increasing – is a more important predictor of returns than dividend yield.

Investors face a returns conundrum. Which combination is best?

High yield, high growth?
High yield, low growth?
Medium yield, medium growth?

Some models suggest a low yield, high growth strategy would produce more long-term value for investors. As interest rates rise, a more mature company with a high dividend yield may have less leeway to increase the dividend than a smaller company with higher growth.  Dividend growth that outpaces inflation can help protect investment returns. From 2005 to 2015, dividend growth averaged 4.97 percent and yield 2.07 percent, while inflation grew at 2.28% over the same period.

Smart Beta ETF Returns by Dividend Yield Factor

The smart beta dividend ETFs selected below each track a different index that meets the defensive duo combination of regular and rising dividend payments. The Vanguard Dividend Appreciation ETF wanders farther out on the risk spectrum by using a cut off of only 10 years of increasing dividend payments. This allows higher exposure to technology stocks, which typically are underrepresented in dividend ETFs because their shorter history precludes them from meeting the 20-year dividend criteria.

Smart Beta ETF 1-year Return 3-year Return 3-year Return Benchmark Yield
iShares Select Dividend ETF (DVY)iShares Select Dividend ETF (DVY) 15.41 10.88 11.51
Dow Jones U.S. Select Dividend Index
Vanguard’s Dividend Appreciation ETF (VIG) 16.92 9.13 8.55
NASDAQ U.S. Dividend Achievers Select Index
SPDR S&P Dividend ETF (SDY) 18.17 10.40 8.42
S&P High Yield Dividend Aristocrats Index
ProShares S&P MidCap 400 Dividend Aristocrats ETF 15.84    – 10.37
P MidCap 400® Dividend Aristocrats® Index

Source: Morningstar

As always, when choosing a smart beta ETF ensure it fits into the overall risk-return profile of your investment portfolio.

Corey Philip

Corey Philip is the founder of RealSmartBeta.com. His focus is on expanding investor knowledge of Smart Beta ETFs and quantitative investing. Learn more about Corey in the 'ABOUT' section of this website.

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