Taking A Closer Look At iShares Dow Jones Select Dividend ETF

| About: iShares Select (DVY)
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Dividend stocks have been very popular of late. In fact, so popular that there is a growing chorus of concern that they might be overvalued. In completing some earlier analysis, I looked at the attractiveness of several dividend stock ETFs and wanted to take some more time to focus in on iShares Dow Jones Select Dividend Index (NYSEARCA:DVY). DVY is one of the more popular dividend stock ETFs with $11.8 billion of assets under management and a very healthy daily trading volume. The AUM figure is actually larger than either SPDR S&P Dividend ETF (NYSEARCA:SDY) at $11.0 billion or Vanguard High Dividend Yield Index ETF (NYSEARCA:VYM) at $7.5 billion. However it is smaller than Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) at $17.6 billion.

DVY Has Attractive Dividend Growth Compared to SDY

DVY has a good recent track record of dividends and perhaps more interesting, a nice acceleration in growth. The following table shows this dividend growth as well as the TTM dividend growth.

DVY Dividends
Ex-date Amount TTM Y-on-Y TTM Growth
3/25/2013 0.562 2.176 15.4%
12/19/2012 0.551 2.120 14.7%
9/25/2012 0.528 2.012 9.3%
6/19/2012 0.535 1.948 8.3%
3/26/2012 0.506 1.886 7.7%
12/22/2011 0.443 1.848 8.5%
9/23/2011 0.464 1.841 8.4%
6/24/2011 0.473 1.799 7.7%
3/25/2011 0.468 1.751 6.6%
12/22/2010 0.436 1.703 2.5%
9/23/2010 0.422 1.698 -4.9%
6/24/2010 0.425 1.671 -14.1%
3/25/2010 0.42 1.643 -24.6%

Source: Yahoo!Finance, Author Calculations

So one can note the double digit growth rate in the recent quarters, as well as the nice acceleration from the depths of the financial crisis. This growth trajectory is much more attractive than SDY, which I've posted below:

SDY Dividends
Ex-date Amount TTM Y-on-Y TTM Growth
3/15/2013 0.355 1.862 5.7%
12/21/2012 0.583 1.909 9.8%
9/21/2012 0.475 1.834 6.1%
6/15/2012 0.449 1.792 3.0%
3/16/2012 0.402 1.762 1.2%
12/16/2011 0.508 1.738 -3.8%
9/16/2011 0.433 1.729 -0.1%
6/17/2011 0.419 1.739 1.6%
3/18/2011 0.378 1.741 0.5%
12/17/2010 0.499 1.806 -1.2%

Source: Yahoo!Finance, Author Calculations

Notice that SDY dividend growth is much more irregular and even shows some later dips. This is clearly a less attractive growth trajectory.

However, it is all relative...

However, the following table for SPDR S&P 500 ETF (NYSEARCA:SPY) is pretty eye popping.

SPY Dividends
Ex-date Amount TTM Y-on-Y TTM Growth
3/15/2013 0.694 3.183 20.7%
12/21/2012 1.022 3.103 20.5%
9/21/2012 0.779 2.851 15.9%
6/15/2012 0.688 2.697 10.7%
3/16/2012 0.614 2.637 12.7%
12/16/2011 0.77 2.576 13.7%
9/16/2011 0.625 2.459 11.6%
6/17/2011 0.628 2.436 15.5%
3/18/2011 0.553 2.339 11.6%
12/17/2010 0.653 2.266 4.1%
9/17/2010 0.602 2.203 -4.5%
6/18/2010 0.531 2.109 -15.3%

Source: Yahoo!Finance, Author Calculations

So SPY provides an even more attractive dividend growth rate with a strong track record of double digit percent increases. At first glance this might be a bit surprising, but the reality is that Dividend Stock ETFs appear to be constructed to provide current income benefits, decent potential for capital appreciation, some inflation protection (relative to bonds), but the lower growth is a result of higher payout ratios. The table below shows the payout ratios for SPY, DVY and SDY.

Payout Ratio and Yield
Ticker Payout Ratio Dividend Yield
DVY 54% 3.7%
SDY 45% 2.8%
SPY 31% 2.1%

Source: Zacks.com, SPDR website, iShares website, Author calculations. Payout ratio here is computed based upon actual ETF holdings and applying a weighted average to compare dividends to earnings.

One can see a clear relationship between payout ratio and yield. Incremental yield today is essentially acquired by choosing high payout stocks and thus sacrificing yield tomorrow from a lower rate of reinvested earnings.

Sector Exposures can also Drive Dividend Growth

Another key consideration is to look at how Dividend Stock ETFs will perform in the future. The underlying dividend growth can be driven by sector exposure.

Sector Allocations
Finance 14.3% 10.6% 16.7%
Utilities 14.0% 32.6% 5.8%
Consumer Staples 12.6% 16.0% 8.1%
Industrial Products 11.4% 4.5% 2.6%
Retail-Wholesale 10.3% 3.7% 8.9%
Basic Materials 8.4% 3.8% 3.2%
Medical 7.4% 4.2% 11.8%
Computer and Technology 5.5% 4.7% 16.7%
Oils-Energy 3.1% 3.8% 10.5%
Consumer Discretionary 2.9% 2.1% 4.8%
Construction 2.7% 2.2% 0.6%
Conglomerates 2.5% 1.5% 3.6%
Aerospace 1.9% 5.7% 1.3%
Business Services 1.5% 3.1% 2.6%
Auto-Tires-Trucks 1.5% 1.3% 1.2%
Transportation 0.0% 0.0% 1.8%

Source: Zacks.com for sector classification and input data, Yahoo!Finance, iShares website, www.spdrs.com, author calculations.

This analysis reveals clear differences in exposures relative to the broader market. Both SDY and DVY lag SPY in exposure to financials. This is probably driven by the Great Recession when many financials cut their dividends. DVY lacks big name banks and its exposure is through companies like Mercury General Corp (NYSE:MCY), Bank of Hawaii (NYSE:BOH), and Allstate Corporation (NYSE:ALL). SDY's exposure is through HCP, Inc. (NYSE:HCP), a healthcare REIT, and then AFLAC, Inc. (NYSE:AFL). In contrast, SPY has the usual suspects of JPMorgan Chase & Co. (NYSE:JPM), Wells Fargo & Company (NYSE:WFC), and Citigroup, Inc. (NYSE:C). JPM provides a dividend yield of 2.2% and WFC is around 3.0%, respectable and above the market average, but nothing to be excited about. I won't mention C's yield.

As one would expect, the SDY and DVY, with their focus on dividends, are significantly underweighted relative to the market in Technology. In contrast, DVY carries a significant exposure to the utility sector with almost 6x then general market exposure and over twice as much as SDY. DVY is very exposed to Entergy Corporation (NYSE:ETR), Integrys Energy Group (NYSE:TEG) and DTE Energy Company (NYSE:DTE) which are 3 of its top 11 positions. This significant exposure to utilities is not unexpected, but could pose future risks, especially for DVY.

Somewhat surprisingly, they are also underweighted in Oils & Energy with a mixed approach to some of the more popular dividend stocks in that area. The following table shows the breakdown of five select stocks in this area and weightings in each ETF.

Oils & Energy Exposure
Name Ticker Dividend Yield SPY SDY DVY
Exxon Mobil Corp. XOM 2.8% 2.8% 1.4% 0.0%
Chevron Corp. CVX 3.3% 1.7% 1.7% 2.2%
ConocoPhillips COP 4.3% 0.5% 0.0% 1.5%
Occidental Petroleum Corp. OXY 2.8% 0.5% 0.0% 0.0%
Kinder Morgan Inc. KMI 4.0% 0.2% 0.0% 0.0%
Total 10.5% 3.1% 3.8%

Source: Zacks.com for sector classification and input data, Yahoo!Finance, iShares website, www.spdrs.com, author calculations.

The other broad consideration from sector concentration is that SDY carries a much more diversified approach than DVY. SDY's top three sectors are just 41% of its portfolio, with no single sector above 15%. It also has two additional sectors, after the top three, above 10%. In contrast, DVY's top three sectors are almost 60% of its assets with over 32% in the utility sector alone. For reference, SPY also reflects the diversification of the market as whole. Its top three sectors are Medical, Finance, and Computers & Technology.

Perhaps Dividend Stock ETFs are Best Suited for Current Income

This analysis is similar to some previous analysis that I did with SDY and resulted in similar observations. With this second data point, I would venture a hypothesis around the use of Dividend Stock ETFs. That hypothesis would be that they are more useful for providing a current income stream rather than as a vehicle for saving over time. I think I would prefer to take the lower yield and more attractive growth rates from SPY. This partially due to the fact that the SPY companies appear to reinvest their earnings at a higher rate. A caveat would be to check if there are more share buybacks in SPY companies than in DVY or SDY companies since buybacks are the alternative way to return capital. Over time this should drive higher price appreciation with the added benefit of delaying taxes (for taxable accounts) from incremental dividend yields. So as noted before, a Dividend Stock ETF might be best if you need to generate current income. Their higher yields should help with that while maintaining general equity market exposure.

I'll be writing a follow up article to this to compare Vanguard High Dividend Yield Index ETF with Vanguard Dividend Appreciation ETF . The purpose of the follow up article will be to see if this trend continues and to also identify the key differences between these two ETFs.

Disclosure: I am long SDY, SPY. 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.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security. I may initiate a long position in DVY over the next 72 hours.