iShares Core Dividend Growth ETF: A Stable, Low-Risk Fund

Summary

• DGRO is a highly diversified fund that closely tracks the Morningstar US Market IndexSM.
• The ETF has witnessed an upward momentum and is currently 10% off its 52-week high.
• Valuation seems appropriate for the investment and the dividend yield looks decent, especially amidst low interest rates.
• I do much more than just articles at The Lead-Lag Report: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

If you missed out on the recent rally in stock markets and are looking to invest in a diversified fund, then the iShares Core Dividend Growth ETF (NYSEARCA:DGRO) could fit your needs. In an environment of low interest rates, the fund offers a stable source of yield to its investors. At its low, the fund had a 12-month trailing yield of 3.4%, which now currently stands at 2.5%. And not only has it provided a consistent yield, but it also developed a strong momentum in share price from April onward. Currently, it is positioned at only 10% below its 52-week high, which, in this environment, is the value tilt you might want to change to after growth has surged.

Break down of its constituents

The fund looks to replicate the performance of Morningstar US Market IndexSM that is a highly diversified index almost covering the entire universe of publicly-traded stocks in the US. In terms of sector-wise breakdown, the portfolio seems highly distributed.

Source: Seeking Alpha

Source: Seeking Alpha

With Financials being a heavyweight in the portfolio, the fund has benefitted from the recent rally in bank stocks as yields have increased in spread and level. Even if the sector was to come under some pressure, looking at the dividend yields of JPMorgan Chase & Co. (3.45%) (JPM) and Wells Fargo & Co. (7.08%) (WFC) should provide some downside protection. The other two leading sectors are Technology and Healthcare, which have been less affected by the pandemic and are back on track, with several technology majors trading at new all-time highs.

Microsoft (MSFT), Johnson & Johnson (JNJ), Apple (AAPL), Chevron (CVX), and Verizon Communications (VZ) are just a handful of names in the top 10 holdings, all of which have been around for decades and will likely be around much longer. Collect these major dividends and wait.

The average valuation of the ETF also indicates that there is plenty of upside possibility in the fund.

Source: Yahoo Finance

Prior to the impact of the pandemic, a P/E of 20 could have been taken as appropriately valued. Though many would contest that such valuations were not backed up by necessary earnings, most firms among the top 10 holdings of DGRO have the potential to perform even during a recession and have managed to find new revenue streams to fuel growth. With the banner jobs report on Friday where 2.5 million jobs were added back, the U- or V-shaped recovery is looking more probable, which could be bullish for this ETF as well.

Initially, we highlighted the significance of stable dividends, especially where the interest rate on debt instruments is low. The fund also manages to outperform its peers in this aspect.

Source: Seeking Alpha

From the table above, HDV is an outlier considering the fact that it focuses on high-dividend paying stocks with a significant difference in its composition. In spite of it, DGRO has managed to outperform its growth rate in the past 3 years. The yield is of HDV is, however, significantly higher than the others. So, many would argue that one should pursue the higher yield fund. Digging deeper, some of its top constituents are similar to Exxon (XOM), which is already facing immense pressure during an oil price rout. The company is very unlikely to provide its estimated yield of 7% if there is no significant recovery in the economy.

What if the slowdown continues?

The high diversification level of DGRO indicates that it is banking on the overall economy rebounding. Numerous economic factors could put pressure on the return and it is essential to understand the capability of the firms in paying their dividends versus the likelihood of cutting or cancelling them.

A look at the balance sheet of the top 5 firms gives some comfort, however:

	Cash (in $bn)	Current Ratio
Microsoft	11.7	2.90
Johnson & Johnson	15.5	1.31
Apple	40.1	1.50
Chevron	8.5	1.01
Verizon	7.0	0.99

Click to enlarge

Data based on Q1-20 results

Apart from Verizon, all other firms have a current ratio of greater than 1 and a healthy cash balance. The impact on most of the sectors could be minimal as technology giants like Microsoft and Cisco are looking to leverage the opportunity created through remote working arrangements by companies. While this may not be sufficient to replicate the high growth in the rate of dividends, it can be expected that the investors could at least receive some form of a dividend, even if the economy does not fully recover. With bank deposits and short-term rates almost at 0%, the respective yield is attractive.

	Growth Rate 1-year (TTM)
Microsoft	9.88%
Johnson & Johnson	5.93%
Apple	7.80%
Chevron	6.25%
Verizon	2.11%

Click to enlarge

Source: Seeking Alpha

Other Factors in its favor

The fund has a 5-year monthly beta of 0.95 that highlights its ability to track the index with minimal error. The expense ratio is also on the lower side at 0.08%. Moreover, the diversification benefit it provides should not be ignored. Any investor betting on ETFs focusing on a specific sector or themes like value or growth may be taking on too much risk. The higher-yield ETFs, too, assume a higher level of risk that may not fall within the appetite of many investors, especially those who need the yields for living expenses. DRGO seems to have the best of both worlds.

Risks to consider

High Growth in Dividends may not be sustainable: The trailing 12-month yield that the ETF generated was on account of double-digit growth in dividends. While the growth may not be sustainable, there is a possibility that the dividend payout may actually fall.

Too diversified: While diversification may be a good practice, the benefit of it could actually diminish at a certain stage. Further additions of stock at that instant would add to the burden of tracking, without much benefit.

The rally could come to a halt: The ETF has managed to recover most of its losses since March and may not provide substantial capital appreciation if the wider markets do not make progress.

Investors should look at the ETF as a safe investment with a decent yield. While a lot depends on the broader market for its performance, DGRO certainly has a medium- to long-term narrative backing it up. A bird in the hand is worth two in the bush, as the saying goes, and DRGO is like having several large geese in your hands giving you juicy dividend payments while you wait.

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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 writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.