Vanguard Dividend Appreciation ETF Is A Buy In 2014

Mar.10.14 | About: Vanguard Dividend (VIG)

Summary

Will benefit from continued investor interest in dividend paying companies and funds.

Expect to see dividend payouts rise by many major U.S. companies this year, which will directly benefit VIG.

Provides diversification at a fraction of the cost of traditional mutual funds.

The purpose of this article is to determine the attractiveness of the Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) as an investment option. To do so, I will look at recent fund performance, current holdings and allocation, and trends in the market to attempt to determine how well it will do in 2014.

To start, a little about VIG. The fund seeks to track the performance of the NASDAQ US Dividend Achievers Select Index. The fund attempts to hold the same proportions of its stocks as their weightings in the index. The Vanguard Group, Inc., through its Quantitative Equity Group, serves as the investment advisor of the Fund. VIG is currently trading at $75.48/share and pays a quarterly dividend of $.40/share, which translates to an annual yield of 2.1%. Recently, the fund has performed strongly, with a return of over 16% in the past 52 weeks, excluding dividends.

Clearly, recent investors in VIG have been rewarded handsomely. The fund has rallied along with the market as a whole and has benefited from the growing trend of investors seeking dividend paying ETF's, funds, and stocks. However, strong performance alone is not a good enough differentiator, because the market as a whole has rallied strongly since 2013, including many of the ETF's that compete with VIG for investor interest, such as SDY and DVY. To get a sense of why VIG may do well this year, it is important to consider its holdings. Here is a list of its top 10 holdings, which make up 36% of the fund's portfolio (at the start of 2014):

Rank: Holding: Weight:

1 Abbott Laboratories (NYSE:ABT) 3.9%
2 PepsiCo Inc. (NYSE:PEP) 3.9%
3 Procter & Gamble Co. (NYSE:PG) 3.8%
4 Wal-Mart Stores Inc. (NYSE:WMT) 3.8%
5 Coca-Cola Co. (NYSE:KO) 3.6%
6 United Technologies Corp. (NYSE:UTX) 3.6%
7 Exxon Mobil Corp. (NYSE:XOM) 3.6%
8 Chevron Corp. (NYSE:CVX) 3.4%
9 McDonald's Corp. (NYSE:MCD) 3.3%
10 3M Co. (NYSE:MMM) 3.1%
Click to enlarge

The above holdings represent some of the best brands in the U.S. economy, so a bet on this fund can almost be seen as a bet on the economy as a whole, which I expect to continue to modestly grow in 2014. What I also like about VIG is its sector weightings, with consumer goods, industrials, and consumer services as its three largest weightings, respectively. The American consumer has begun spending again, so these sectors will continue to do well. With unemployment dropping across the U.S., this is a trend that will surely continue, and many consumers are increasing their spending on services in recent months. What I also like about VIG, given that interest rates at set to rise over the next 6-18 months, is its lower weighting towards the utilities sector, at just over 1%. While utilities companies typically pay high, and reliable, dividends because of their steady cash flows, historically they do not outperform during periods of rising interest rates. This low weighting won't allow that scenario to be a drain on VIG, the way it might on competing fund DVY, which has a weighting of a whooping 34.51% in utilities. This significant difference could allow VIG to outperform DVY in the short-term.

An additional advantage of VIG is its low expense ratio. While many mutual funds charge in the range of 1-2% annually, VIG has an expense ratio of just .10%. This is extremely low, and for the amount of diversification VIG provides, with a current portfolio of 146 stocks, is an absolute bargain for the money. Even compared to other ETF's this fund is cheap to own, with SDY charging an expense ratio of .35% and DVY charging .40%. Saving on expense fees can really add up over time, especially for long-term investors who hold these funds for years, and can help compound returns, to the point where it can make up for a slightly lower yield or price return. This is important because VIG has a lower yield than SDY and DVY, which currently yield 2.6% and 3.1%, respectively. Some investors may screen out VIG on the subject of dividend yield alone, but it is important to consider all aspects of a fund, including expenses, before selecting one over the other.

One aspect I do not like about VIG is its low weighting towards financials, currently at 7.6%. While there is clearly a reasonable argument to be made for being cautious of financials given the recent recession, financial stocks have rallied since the beginning of 2013 and are attractive investments going forward. I see financials such as banks and investment companies continuing to do well as home prices appreciate and unemployment continues to drop. I see each of those trends continuing, so I would prefer the fund to add to its financials allocation. However, as the fund attempts to keep expenses low by not being actively managed, it could take some time for this to occur.

Bottom line: If you are buying VIG for stock appreciation because of confidence in large cap U.S. stocks, the proper risk reward is there. VIG has been performing strongly, and I expect investors to continue to be attracted to dividend paying ETF's because of their low fees, easy diversification, and dividend payouts. With a strong quarter of corporate earnings behind us for many U.S.-based companies, and due to the fact that these same companies continue to hold record amounts of cash, to the tune of almost $3 Trillion, expect dividend payouts to rise in 2014 and 2015, directly benefiting funds like VIG. Since VIG holds in its portfolio many cash rich companies, and sports a relatively safe beta of .85, I would encourage long-term investors to take a serious look in to this fund.

Disclosure: I am long DVY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.