Finding The Best Dividend Growth Stocks

Includes: DVY, HDV, SDY, VIG, VYM
by: The Dividend Guy

If you have been reading my articles for a while, you already know that chasing high dividend yield stocks or picking in only one sector won't cut it if you want to build a strong dividend growth portfolio. There is only one way to build such a portfolio and it's to pick among the best dividend growth stocks. I'm not the kind of investor who's looking for a fast lane to pick-up "hot stocks" but I found a way to "secure" your dividend stock picking process.

But first, here's some information for those who think that we have entered into a dividend bubble.

Is It The Right Time To Invest In Dividend Growth Stocks?

There is a rumor in the trading industry that we have entered in a dividend stock bubble. The rumor states that dividend stocks are mainly bought by investors seeking a steady yield. When you look at the overall S&P 500 dividend yield vs the 10 yr Treasury Bond yield, you can understand why:

Since 2011, the S&P 500 dividend yield is paying more than the 10 yr bill! This simply means that you can't find a good yield in bonds, certificates of deposit or treasury bills. Buying solid dividend growth stocks seems quite attractive as you can easily earn a 3% dividend and hope to see your stock value grow over time. This is why investors, portfolio managers and even ETFs have poured their assets massively into dividend growth stocks. The first money movement was targeted on high dividend yield stocks. If there is a bubble growing, it is probably that part of the dividend stocks you want to avoid; stocks with dividend yield over 4.50% may be too pricey for the moment.

However, it doesn't mean that the whole market is expensive. In fact, the average P/E ratio for dividend stocks is around 17 right now. Historically, these same stocks were sold at 20. This tells me that they are still trading at a discount. To be honest, I still believe the overall U.S. market is trading at a discount right now, so this is in line with my own theory. On the other hand, a high dividend yield sector such as Utilities currently shows a P/E ratio around 28. It's useless to say that you are now paying a high premium to earn dividend payouts from this sector. Industrial and Financial sectors seems to be the best bets for undervalued stocks vs dividend yield at the moment.

The Ultimate Tip to Find the Best Dividend Growth Stocks

The reason why I've made such a long intro wasn't to plug a nice graph and tell you that dividend stocks are cheap right now. It's also not to show you that dividend growth stocks are better than the average stock market (you know that already, don't you?). I wanted to make a point; the point is that everything is pointing towards dividend investing.

While dividend investing has always been somewhat popular, I think it's gaining a new edge due to the super low interest environment we are in. There are no other choices for retirees but to take a leap of faith and invest a part of their money into dividend growth stocks. But this is darn scary for anyone who has never really played the stock market before. And what do people do when they feel uncomfortable about something? They seek professional help-- this is why mutual funds and ETF portfolio managers smelled the money from profits and boosted their dividend investing product offerings. If you have little to no experience in buying stocks, the smart and logical thing to do will be to invest in a diversified and professionally managed investment product. This is why dividend mutual funds and dividend ETFs grew like wheat in Central Canada for the past five years. Here are a few of the most popular dividend ETFs:

Objective Stock Selection Process Avg Yield Market Cap ($B)
VIG Div Growth Dividend increase each year for the past 10 years + payout ratio requirements. 2.10% 10.18
SDY Div Growth Must be part of S&P 500 composite 1500 and show dividend increase for 20 consecutive years. 3.10% 9.49
DVY Div Growth 5 year dividend growth rate must be positive + dividend payout ratio under 60%. 3.50% 10.87
VYM High Yield Aim for high dividend yield stocks excluding REITs. 2.90% 4.23
HDV High Yield 75 high dividend yield stocks screened through by several metrics to forecast business sustainability 3.20% 2.27

As you can see, I posted 3 dividend growth and 2 high dividend yield oriented ETFs. The most important column in this chart is the last one: the market cap. Solely within these 5 dividend ETFs, there are $37 billion invested. This tells you one thing: Dividend ETFs are boosting several dividend growth stock values on the market.

Check Out the Top Holding Dividend ETFs

By selecting stocks from top holding ETFs, you gain a lot of benefits:

  • You buy a stock that has been professionally selected by most dividend portfolio managers (reducing your potential trading losses)
  • You make sure that there is some kind of value support on your stocks (as most investors will reinvest their ETF's dividends back into the ETF itself which will buy more of these stocks)
  • You make sure that there is a potential for growth in the value of your stocks (as most investors are turning towards dividend investing, this should increase the demand for dividend growth stocks)

I've looked at some of the biggest dividend ETFs and here's a short list of top dividend growth stock holdings currently held (in alphabetical order)

Top Dividend Growth Stocks Held In Dividend ETFs

Ticker Name Div Yield
CL Colgate-Palmolive 2.36%
CVX Chevron Corp 3.32%
EMR Emerson Electric 3.21%
GD General Dynamics 2.96%
IBM International Business Machines 1.76%
JNJ Johnson & Johnson 3.44%
KMB Kimberly-Clark 3.55%
KO Coca-Cola 2.75%
MCD McDonald's 3.55%
MDT Medtronic 2.48%
MMM 3M Co 2.65%
MRK Merck & Co 3.65%
PEP PepsiCo 3.11%
PFE Pfizer 3.58%
PG Procter & Gamble 3.25%
PPG PPG Industries 1.97%
T AT&T inc 5.04%
UTX United Technologies 2.74%
WMT Wal-Mart 2.18%
XOM Exxon Mobil Corp 2.53%

I was happy to find 3 of my own stocks on this list (KO, CVX and JNJ). There are a lot of dividend growth stocks from the consumer sector in this list. This is a great way to build your core dividend growth portfolio. However, keep in mind that since they are "popular stocks", they may be trading at a higher P/E ratio. Therefore, you buy these stocks for their dividend growth potential but forget about a surge in the stock value!

Warning: I'm not telling you that blindly buying the top holdings of any ETF will work. In fact, you can simply buy the dividend ETF instead and save on trading fees. But if you apply your own stock screening process and find similar stocks amongst the top holdings in dividend ETFs, you have a good indication that these stock values will be supported for a long time.

Disclosure: I own shares of KO, CVX, JNJ.