Is The Vanguard High Dividend Yield ETF Primed For Dividend Growth?

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 |  About: Vanguard High Dividend Yield ETF (VYM), Includes: AAPL, ABBV, ABT, BA, BMY, COP, CSCO, CVX, GE, INTC, JNJ, JPM, KO, MCD, MMM, MRK, MSFT, PEP, PFE, PG, PM, T, VZ, WFC, WMT, XOM
by: FinancialStorm

Summary

VYM is an ETF sometimes cited on Seeking Alpha as a potential component of a dividend growth portfolio.

The top 25 holdings comprise almost 59% of the fund's assets.

A pessimistic projection of potential dividend growth from those top 25 holdings comes in around 4.4%.

Vanguard High Dividend Yield ETF (NYSEARCA:VYM) is an exchange traded fund, which seeks to track the FTSE High Dividend Yield Index [see link for a description of the FTSE index]. It has a low expense ratio at 0.10% and a SEC Yield of 3.03% (as of 4/23/2014).

While the summary information for VYM does not make explicit mention of dividend growth as an objective of the ETF, VYM frequently comes up on Seeking Alpha in discussions of ETFs that could be useful vehicles for dividend growth investors who are seeking broad diversification and a passively-managed option. In this article, I pull out the top 25 holdings of VYM, as reported by Morningstar, and try to get a feel for whether this portfolio of holdings can be expected to deliver meaningful dividend growth. These holdings represent roughly 59% of VYM's portfolio.

Let's get straight to it. Here are the top 25 holdings, based on the number of shares owned (reported on 3/31/2014) and April 24's market value (source for # shares owned: Morningstar).

Name

Ticker

Shares

Value

Apple Inc

AAPL

1202064

$681,762,618.24

Exxon Mobil Corporation

XOM

5823401

$583,912,418.27

Microsoft Corporation

MSFT

10103048

$397,959,060.72

General Electric Co

GE

14549148

$386,425,370.88

Johnson & Johnson

JNJ

3700873

$370,901,492.06

Wells Fargo & Co

WFC

7127652

$352,604,944.44

Chevron Corp

CVX

2572764

$320,283,390.36

Procter & Gamble Co

PG

3663140

$296,970,759.80

JPMorgan Chase & Co

JPM

5120635

$287,574,861.60

Pfizer Inc

PFE

8601754

$264,245,882.88

Verizon Communications Inc

VZ

5567847

$257,401,566.81

AT&T Inc

T

7042668

$244,169,299.56

Coca-Cola Co

KO

5701945

$232,696,375.45

Merck & Co Inc

MRK

3943689

$227,787,476.64

Intel Corp

INTC

6732818

$180,978,147.84

Philip Morris International, Inc.

PM

2136306

$179,107,895.04

PepsiCo Inc

PEP

2051769

$175,097,966.46

Wal-Mart Stores Inc

WMT

2185887

$170,980,081.14

Cisco Systems Inc

CSCO

6942102

$162,653,449.86

McDonald's Corporation

MCD

1333985

$133,265,101.50

3M Co

MMM

893900

$122,026,289.00

ConocoPhillips

COP

1636781

$121,891,081.07

Boeing Co

BA

911664

$118,333,987.20

Bristol-Myers Squibb Company

BMY

2224529

$112,672,393.85

AbbVie Inc

ABBV

2118990

$104,762,865.60

Click to enlarge

Right away, we see a number of very familiar names; although, not every name on the list has a long-standing record of yearly increasing dividends. Using David Fish's U.S. Dividend Champions spreadsheet, I pulled out the number of years each holding had increased dividends. A count is below:

Number of years increasing dividends

Number of holdings

0-4

9

5-9

3

10-24

3

25+

10

Click to enlarge

We see that 40% of the top-25 holdings have 25+ year records of dividend increases, which provides a solid foundation if we are hoping for future dividend growth.

There is also a significant number of stocks without at least a 5 year history of dividend growth. A look at a few of the names - Apple, General Electric, Wells Fargo - suggests that some of the names in this category, at least, are names that investors do have some expectation for future dividend growth. Apple, the newest addition to the VYM portfolio, instituted a dividend in 2012, hiked it shortly after, and just raised it roughly 8% again. Both General Electric and Wells Fargo had histories of dividend growth before the financial crises, and we can be hopeful that they are trying to reestablish themselves as dividend growers; although, with the banking names, there are of course potential regulatory hurdles. AbbVie was recently spun off from Abbott Laboratories (NYSE:ABT) and hasn't been around long enough to establish track record on its own.

Rough Dividend Growth Lower Bound

I wanted to get a feel for what might be a reasonable expectation of dividend growth from this portfolio. To do this, I first figured out how much income each position would generate based upon the currently announced distribution. Then for each equity, I selected a percentage by which I would increase this income.

I prefer to make pessimistic forecasts when using quantitative data, so I selected the percentage by which the income would increase as the minimum of the most recent dividend increase, the 1-year dividend growth rate, the 5-year dividend growth rate, and the 10-year dividend growth rate [all of this data is due to David Fish's remarkable spreadsheet, linked earlier]. In the event that a company had not grown its dividend for 5+ years, I projected zero growth. I then computed the income the portfolio would throw off if the dividend growth numbers applied. This resulted in a projection of roughly 4.4% greater income after 1 year. The numbers used in making this forecast are:

Name "Forecast" dividend growth %
Apple Inc 0
Exxon Mobil Corporation 9.6
Microsoft Corporation 15
General Electric Co 0
Johnson & Johnson 7.1
Wells Fargo & Co 0
Chevron Corp 9
Procter & Gamble Co 7
JPMorgan Chase & Co 0
Pfizer Inc 0
Verizon Communications Inc 2.8
AT&T Inc 2.22
Coca-Cola Co 8.1
Merck & Co Inc 0
Intel Corp 3.4
Philip Morris International, Inc. 10.4
PepsiCo Inc 6.4
Wal-Mart Stores Inc 2.13
Cisco Systems Inc 0
McDonald's Corporation 5.19
3M Co 4.9
ConocoPhillips 4.55
Boeing Co 0
Bristol-Myers Squibb Company 2.3
AbbVie Inc 0
Click to enlarge

Interpreting this number

Do I think that 1 year from now the income generated by these 25 stocks, as weighted by VYM, will be precisely 4.4% higher? Absolutely not. However, I think this is a starting point for thinking about what it might actually be.

First, there are some places where our growth projection might actually be optimistic. In particular, Intel has recently missed several opportunities to raise its dividend. In the case of Proctor & Gamble, the most recent dividend increase of about 7% was used in computing the future, and a pessimistic estimate would suggest that next year's dividend growth will be less than this year's. Similarly for AT&T, Wal-Mart, McDonald's, and ConocoPhillips.

On the other side of the coin, all 9 equities which have not had 5+ years of dividend growth histories were assigned to have flat dividends for this calculation. I don't think this is realistic, and it's reasonable to think that Apple, General Electric, Wells Fargo, JPMorgan Chase, Cisco, and AbbVie are likely to put in some dividend growth. In addition, there are some dividend grower's whose growth rate is trending up, suggesting that the pessimistic assumptions used to project future growth are likely to be low: Exxon Mobil, Microsoft, Johnson & Johnson, Chevron, Coca-Cola, PepsiCo, and 3M Co.

I don't have a number to offer for what will actually happen, but my personal opinion is that taken together, these 25 names, as weighted in VYM, will produce dividend growth greater than 4.4%.

Disclaimer: By no means should this article be interpreted as a complete analysis of the investment merits of VYM. This is a look at a single aspect of such an investment.

Disclosure: I am long VYM, MSFT, INTC, VZ, PG. 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.