Especially when the market is rough, dividends can play an incredibly powerful role in delivering investing returns. After all, cash stays around as cash, and while it may lose purchasing power to inflation over time, cash won't disappear overnight just because the market is in a bad mood.
Even better, once paid, the cash from those dividends is versatile. You can use it to pay your bills, to buy more shares of stock, or keep it around until the market makes you an offer you truly can't refuse.
Yet, if there's a problem with dividends, it's that they're never guaranteed payments. If a company gets into trouble, its dividend may very well be one of the few substantial costs it can cut without causing itself massive operational challenges.
That makes it critically important to focus not just on dividend size, but also dividend quality when investing in dividend paying stocks. Fortunately, though, you don't have to do all that work and try to pick winners when looking for dividend stocks. The reason why is simple: it's now possible to buy low cost ETFs that specialize in finding stocks with a decent history of increasing their dividends and reasonable prospects of continuing those trends.
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When dividend payment meets growth potential
One such ETF is the iShares Core Dividend Growth ETF (DGRO -0.14%). That ETF carries a modest 0.08% expense ratio, meaning nearly all of the returns of its holdings make their way to the ETF's investors. As implied by its name, the iShares Core Dividend Growth ETF attempts to track an index focused on companies with a history of rising dividends.
That index, the Morningstar US Dividend Growth Index, can't guarantee that its picks will increase their dividends. Still, the process it uses does a reasonable job of attempting to screen in only ones that look like they can do so. Key highlights of that process :
- It only includes companies with at least a five-year history of rising dividends.
- It filters out REITs and otherwise qualifying companies with the absolute highest yields.
- It only includes companies with payout ratios below 75%.
- It only includes companies where analysts are expecting earnings growth.
The five-year history helps by seeking out only businesses that have made a serious, multi-year commitment to their dividends. Filtering out REITs helps keep the focus on potential dividend growth, rather than current yield. REITs must pay out at least 90% of their earnings as dividends, which risks leaving little left in the company to reinvest in growth.
Similarly, filtering out the highest yielding companies that would otherwise qualify and only including companies with a less than 75% payout ratio is an attempt to avoid yield traps. As a general rule, when a stock's yield looks too good to be true, it probably is.
The market tends to suppress the share price of companies that look like their dividends may get cut. That boosts their reported yield, until such time as the dividend is actually cut. By putting those filters in place, it makes it less likely that the companies at the most obvious risks of a dividend cut will get included in the index.
And finally, the focus on earnings growth is important, since earnings are the only sustainable source of dividend payments over time. For a company to continue to increase its dividends for the long haul, it absolutely must have enough earnings to support those higher payments.
Put it all together, and you get an ETF with a respectable current yield near 2.6% that has also managed to increase its payment to its owners on a fairly regular basis over time . It's not perfect at delivering dividend growth, but for an automatic investment geared toward not having to pick and choose, it has done a pretty good job over time.
Get started now
As awesome as it can feel to get a dividend payment, the reality is that dividends represent a situation where "you have to be in it to win it." In order to receive that payment, you need to own the payer's stock before those shares go ex-dividend and hold on to them at least until that ex-dividend date.
So if you're considering the iShares Core Dividend Growth ETF or any other dividend payer, make today the day you get serious about looking into it. After all, the sooner you actually invest, the more of those dividends you can potentially receive for yourself.