The Vanguard Dividend Appreciation Index ETF (VIG 1.16%) is a popular exchange-traded fund (ETF). But just because it has the word "dividend" in its name doesn't make it a good income investment.
If you are looking for a combination of yield and dividend growth, PepsiCo (PEP 2.30%) and NextEra Energy (NEE 3.13%) are both in the Vanguard Dividend Appreciation Index ETF, but have much higher yields. Here's why you might want to buy them instead of the ETF.
What does the Vanguard Dividend Appreciation Index ETF do?
The Vanguard Dividend Appreciation Index ETF is an index-tracking ETF, so it doesn't really do anything but buy what the index buys. The index it is tracking is the S&P U.S. Dividend Growers Index, which is fairly simple.
First, it screens for companies that have increased their dividends for at least a decade. Then it eliminates the highest-yielding 25% of stocks. The stocks that remain, currently around 330 companies, are market cap weighted.
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There's nothing inherently wrong with this approach, but it does specifically eliminate the highest-yielding investments. So having the word dividend in the name isn't an indication of a focus on yield. It is simply telling investors that dividends are part of the screening process.
This helps explain why the Vanguard Dividend Appreciation Index ETF's dividend yield is so low, at just 1.8% or so. Yes, that's higher than the roughly 1.3% you'd get from an S&P 500 ETF, but it is hardly a high yield. If you are looking at the Vanguard Dividend Appreciation Index ETF thinking you have found a solution to your income needs, well, you'll probably be let down.
Use the Vanguard Dividend Appreciation Index ETF as a fishing pond
But you don't have to buy Vanguard Dividend Appreciation Index ETF to get some use out of it. You can examine its list of holdings to see if any might be a better choice if you want dividend appreciation and more yield. PepsiCo and NextEra Energy are two top 50 holdings you'll want to look at right now.
PepsiCo is a large consumer staples company that has the leading position in salty snacks (Frito-Lay), is the second-largest beverage maker (Pepsi), and has a solid business in packaged food (Quaker Oats). It is a Dividend King, with over 50 consecutive annual dividend increases under its belt. And it has a historically high dividend yield of 4.3% today.
The yield is high right now because PepsiCo's business isn't hitting on all cylinders. But it is working on the issue, notably buying on-target beverage and food businesses to update its portfolio. Given its status as a Dividend King and its prowess on the innovation, distribution, and marketing fronts, it seems likely that PepsiCo will muddle through the headwinds it faces today, as it has many times before.
Dividend growth has slowed down of late, with the last increase coming in at "just" 5% versus a 10-year average of around 7%.
NextEra Energy is a regulated utility that also operates one of the largest solar and wind power businesses on the planet. On the regulated side of its business, it owns Florida Power & Light, a utility that has benefited from the population growth in the state of Florida for many years. This is a slow and steadily growing division.
The clean energy business, meanwhile, has long been the company's growth engine. Given the shift away from dirtier fuels to cleaner options and renewables, it is likely to have years of growth ahead as well.
NextEra Energy's dividend yield is nearly 3.3%. While that's below the level of some competitors, this "boring" utility has increased its dividend at an annualized rate of 10% over the past decade. And it believes it can continue to increase the dividend at that rate for at least the next couple of years.
The dividend has been increased annually for over three decades. That kind of dividend growth from a utility is nothing short of impressive.
Don't settle for the Vanguard Dividend Appreciation Index ETF
ETFs are easy, but they aren't always the best investment choice. I prefer to dig a little deeper to find stocks that offer me all of what I want. Right now, PepsiCo and NextEra Energy, both of which are owned by the Vanguard Dividend Appreciation Index ETF, are two of the most attractive high-yield dividend growth stocks around.
