When It Comes To Dividends, Looking Back May Cost You

Aug.25.14 | About: WisdomTree U.S. (DGRW)

By Jeremy Schwartz

Today, some of the most widely followed exchange-traded funds (ETFs) that focus on dividend growth employ backward-looking growth screens that require a company to have paid-and in some cases raised-dividends for 5, 10 or even 20 years before becoming eligible for inclusion. This seems like a smart idea, but it keeps many investors from capitalizing on shifting trends in the dividend landscape, specifically when it comes to newer payers and firms recovering from recent dividend contractions.

Dividends have been growing at an incredible pace in recent years, and the Information Technology sector has led the charge, accounting for more than 45% of the increase in dollar dividends. But investors in ETFs that use backward-looking growth screens may not see many of these dividend leaders in their portfolios, potentially for many years.

Over a year ago, WisdomTree launched a forward-looking dividend growth ETF that seeks to capture dividend growth trends that often are not captured by indexes that take a backward-looking approach.

The WisdomTree U.S. Dividend Growth ETF (NASDAQ:DGRW), looks at fundamental metrics that could indicate future dividend growth potential. Two categories of variables govern stock selection:

  1. Quality, defined as companies with high return on equtiy and high return on assets-both key profitability metrics tied to dividend growth potential.
  2. Growth, defined as companies with high expected earnings growth, as future dividends must be funded from cash flows companies generate.

To quantify the cost of looking backward for dividend growth, the chart below shows the performance of DGRW against its benchmark, NASDAQ U.S. Dividend Achievers Select (DVG) Index, which has a 10-year dividend growth look-back screen as part of its methodology.

The Cost of Looking Backward

Click to enlarge

For current performance of DGRW, click here.

Outperformance since Fund Inception - DGRW has outperformed its benchmark index by 4.69%. An approximate 4.5% over-weight to Apple (NASDAQ:AAPL) over the time period contributed 2.3% toward DGRW's outperformance. Even though Apple only reinstituted its dividend in 2012, it is now the second-largest dividend payer in the U.S., and it is responsible for approximately 2.8% of total dividends paid. The NASDAQ U.S. Dividend Achievers Select Index had zero exposure to Apple over the period, and, based on the Index's current methodology, Apple would not be eligible for inclusion until 2023.

Information Technology - DGRW's approximate 13.2% over-weight to the Information Technology sector contributed around 4.3% toward its outperformance. In addition to Apple, an approximate 4.1% and 2.2% over-weight to Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC), respectively, contributed positively to performance. Neither Microsoft nor Intel was a constituent of the NASDAQ U.S. Dividend Achievers Select Index over the period.

Other large technology firms, like Cisco and Oracle, also contributed positively to DGRW over the period. Cisco (NASDAQ:CSCO) and Oracle (NYSE:ORCL), which began paying in 2011 and 2009 respectively, have both already doubled their per-share dividend rate. Neither firm was included in the NASDAQ U.S. Dividend Achievers Select Index over the period.

Looking Forward

Newer technology payers and growers have made the Information Technology sector the second-largest dividend-paying sector, accounting for approximately 15.6% of total dividends. WisdomTree believes that exposure in this sector is important when trying to represent a proxy of the dividend-growth universe in the United States.

I believe that dividend-growth stocks are attractively priced compared with traditional high-dividend-yield stocks. If the U.S. economy continues to improve and interest rates eventually increase, dividend-growth stocks may become even more important as higher-dividend-yielding stocks face pressure from reinvigorated competition that stems from higher bond yields.

Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. Funds focusing their investments on certain sectors increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility. Please read the Fund's prospectus for specific details regarding the Fund's risk profile.

Dividends are not guaranteed, and a company's future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

Jeremy Schwartz, Director of Research

As WisdomTree's Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel's head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper "What Happened to the Original Stocks in the S&P 500?" and the Wall Street Journal article "The Great American Bond Bubble."