iShares Core Dividend Growth ETF Has A Quality Portfolio, But Is Expensive Now

Summary

• DGRO invests in dividend growth stocks in the U.S. that have at least five consecutive years of dividend growth and have payout ratios below 75%.
• The fund has a high exposure to large-cap and giant-cap stocks and may continue to perform well in a post COVID-19 world.
• Stocks in DGRO’s portfolio appear to be overvalued against their historical averages and a pullback will create a better buying opportunity.

ETF Overview

iShares Core Dividend Growth ETF (NYSEARCA:DGRO) focuses on dividend stocks that have five or more consecutive years of dividend growth with payout ratios below 75%. The fund has a high exposure to large-cap and giant-cap stocks. These are companies that have better balance sheet and resources to weather the storm caused by the outbreak of COVID-19. Many of these companies also should outperform peers in a post COVID-19 world. However, these stocks are trading at a premium valuation. The current risk and reward profile may not be that attractive. Therefore, we think a pullback will create a better buying opportunity.

Data by YCharts

Fund Analysis

DGRO focus on dividend growth, not dividend yield

DGRO seeks to track the investment results of the Morningstar U.S. Dividend Growth Index. We have discussed how the index select stocks in our previous article and we will not repeat it again here in this article. Anyone interested in learning more can check here. A quick summary is that DGRO selects stocks that have five or consecutive years of dividend growth with a payout ratio below 75%. Therefore, DGRO focuses on dividend growth instead of high-yield stocks. Below is a chart that shows the dividend paid for DGRO’s top-10 holdings in the past decade. As can be seen from the chart below, its top-10 holdings have increased their dividends for at least five consecutive years.

Data by YCharts

DGRO’s focus in giant and large-cap stocks are beneficial

Nearly 50% and 35% of DGRO’s portfolio consists of giant-cap and large-cap stocks.

Source: Morningstar

These are companies that generally have strong and stable balance sheets than their smaller peers. This is important because this economic recession caused by the outbreak of coronavirus has the potential to last for several years until an effective vaccine is developed, which might take at least 12 – 18 months or longer. Therefore, large and giant-cap dividend stocks should be in better shape than their smaller peers. Fortunately, DGRO’s exposure to small-cap stocks is low. In fact, it only represents about 2.56% of its total portfolio. We think DGRO’s exposure to large-cap and giant-cap stocks will be very beneficial once the economy moves from the recessionary phase to a recovery phase. As an article written by The New York Times says,

What you saw in ’08, ’09 were the companies that were able to continue to invest came out the other side and actually accelerated their growth relative to competitors… And that will probably happens again.

Therefore, we think giant-cap and large-cap stocks in DGRO's portfolio should benefit.

DGRO’s top 10 holdings are companies that should thrive in a post COVID-19 world

DGRO’s top-10 holdings represent about 26.3% of its total portfolio. We will take a closer look at the growth prospect of these top-10 companies and evaluate how they will perform in a post-COVID-19 world. Keep in mind that we think that the economy will not fully recover until a vaccine is developed, which is at least 12 – 18 months away from now (if a vaccine is found). Its top-10 holdings are giant-cap stocks and do have strong balance sheets (see chart below). We will first take a look at the technology stocks in DGRO’s portfolio since four of the top 10 stocks are tech stocks. Microsoft (MSFT) and Apple (AAPL) should continue to do well as many people will continue to rely on their services and devices that enable people to work or do things from home. Other technology companies such as Cisco Systems (CSCO) and Intel (INTC) provide the necessary hardware (e.g. data centers) and network equipment/infrastructure that enable people to work and do things from home. Healthcare stocks such as Johnson & Johnson (JNJ) and Pfizer (PFE) have recession-resilient businesses thanks to an aging global population and the need for medical supplies. Therefore, demand for pharmaceutical and health-related products should remain robust. Procter & Gamble is a consumer staples company with established brands that consumers trust. Chevron (CVX) may be the only company in DGRO’s top-10 holdings that will face strong near-term headwinds as energy demand is likely going to be depressed in the next one to two years. However, Chevron has the potential to thrive thanks to its strong balance sheet as it can be opportunistic and consolidate many distressed energy assets.

Ticker	Company Name	Morningstar Moat Rating	Financial Health Rating	Weighting
MSFT	Microsoft	Wide	Strong	3.29%
AAPL	Apple	Narrow	Strong	3.17%
JNJ	Johnson & Johnson	Wide	Strong	2.95%
CVX	Chevron	Narrow	Strong	2.83%
JPM	JP Morgan Chase	Wide	Strong	2.82%
VZ	Verizon Communications	Narrow	Moderate	2.74%
PFE	Pfizer	Wide	Strong	2.64%
PG	Procter & Gamble	Wide	Strong	2.05%
CSCO	Cisco Systems	Narrow	Strong	1.94%
INTC	Intel Corp.	Wide	Moderate	1.82%
	TOTAL			26.25%

Click to enlarge

Source: Created by author

We cannot make sense of the current valuation

Despite the fact that DGRO has a good growth portfolio, it appears that its top-10 holdings are overvalued. As can be seen from the table below, its weighted average forward P/E ratio of 19.23 is significantly higher than its weighted average five-year P/E ratio of 15.59x. Therefore, DGRO appears to be expensive.

Ticker	Company Name	Forward P/E	5-Year P/E	Weighting
MSFT	Microsoft	29.15	22.73	3.29%
AAPL	Apple	26.81	15.00	3.17%
JNJ	Johnson & Johnson	19.19	16.35	2.95%
CVX	Chevron	N/A	24.25	2.83%
JPM	JP Morgan Chase	15.27	11.69	2.82%
VZ	Verizon Communications	12.03	12.11	2.74%
PFE	Pfizer	13.50	13.32	2.64%
PG	Procter & Gamble	22.12	21.23	2.05%
CSCO	Cisco Systems	15.70	13.95	1.94%
INTC	Intel Corp.	13.91	12.46	1.82%
	TOTAL	19.23	15.59	26.25%

Click to enlarge

Source: Created by author

Investor Takeaway

DGRO has a high-quality portfolio of stocks that should outperform in a post COVID-19 world. However, the fund appears to be expensive right now. A pullback might create a better buying opportunity.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

Comments

[LazyGringo]

We may get a sharp pullback, the Wapo just reported those jobs numbers were actually 3% higher which also shut up Trump about his bogus :miracle" recovery. I sold $700,000 worth end of day Friday send=sing something was amiss. My hunch was right, High quality companies like AAPl and CSCo should be fine but the Covis 19 beaten down trash stocks like oil and airlines up 25% in one way will be going back down most likely,

[northgoingzax]

Maybe the 10 yr yielding a fraction of it's 5 year average is why this portfolio should trade at a premium to it's 5 year average

[repjr]

Agreed. It's a great, low-cost etf. One of the few I own. But I wouldn't buy it right now. Wait for a pull-back. I suspect we'll see one soon enough.

[virtual reality]

This analysis is technically correct but reaches the wrong conclusion. The result is being driven by the re-rating of AAPL and MSFT which are much better companies today their 5 year P/Es would suggest. Valuation is not an issue

[LazyGringo]

Correction, AAPL PE is only 23 and MSFT's is 32, which is a huge imbalance. I think AAPl has a better chance of outgrowing MSFT going forward plus they do a lot more buybacks nd make a lot more money.

[rreuter]

Thank you for an informative article.
I own DGRO, and it's even more expensive Vanguard look alike, VIG. I've been selling small portions of both on up days. My plan is to increase reserves for what I think is the inevitable autumn low.

[Hanover67]

DGRO's expense ratio is 8 basis points. Yes, it would be better to buy it at a lower price. I have owned it for 2 years during which it has ranged between about $33 and $43 per share. My cost is $36+. I DRIP the dividends, which have risen nicely. For example, the 1st Quarter 2020 dividend was 16% higher than in 2019. I originally bought DGRO because I couldn't find individual stocks at attractive prices, as a "safe haven." However, I could have bought it 6 months later for 15% less - so it fluctuates. Right now, I'll settle for compounding and hold.

[RustyTech]

Well said.

[Ted Stamas]

What's the expense ratio? Schwab's $SCHD is a similar etf with only 6 basis points for an expense ratio. Both seem to be in the same ball park.

[DigDugRVA]

0.08% - $11 billion in assets under management in 482 names with 25% in the top 10 and a 12% dividend growth rate over the past 3 years. SCHD has $12 billion in 97 names and 45% in the top 10 with an 11% three year dividend growth rate. Overlap in names in the top 10 between the two are Intel, Pfizer and Verizon. Price to buy DGRO seems to be under $37 historically.

[rcalhoon]

DGRO is a great core holding. I agree that it would be wise to wait for a pull back to add more.

[RustyTech]

Thanks for the article. DGRO is one of the few ETFs I hold. Haven’t added to the position for awhile because it’s been pretty expensive in the past. However, once Covid hit I loaded up. Getting expensive here again.