A Dividend ETF That Will Really Work Over The Long Term

The more familiar an income investor becomes with dividend exchange-traded funds, the more likely he or she is to notice that a frequently used weighting methodology for many dividend ETFs is how long the companies in that fund have increased their payouts.

Let's Look At Dividends

Some well-known dividend ETFs mandate member firms have a minimum dividend increase streak of 10 years, while other funds are more stringent, requiring components to have raised payouts for 20 or 25 consecutive years. That is one approach to finding dividend growth via stocks and ETFs, but simply because something happened last year does not mean it will repeat this year.

That is to say a forward-looking approach to dividend growth should be implemented and that might just explain why the WisdomTree U.S. Quality Dividend Growth Fund (WisdomTree Trust DGRW) is a successful dividend ETF. In less than three years on the market, DGRW has nearly $600 million in assets under management.

While an ETF's assets under management is no more than a superficial metric, DGRW's growth says investors are looking for a fund with some element of predicting future dividend growth, not relying on an index that only tells investors about a company's dividend history.

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“A record of dividend growth is evidence that a firm's managers are committed to a shareholder-friendly payout policy and is a sign of strong and stable profitability. But restricting stock selection to this criterion excludes many emerging dividend-paying firms and ignores forward-looking information about the sustainability of dividend growth,” said Morningstar in a recent note.

What Sets DGRW Apart

DGRW's underlying index uses return on assets (ROA) and return on equity (ROE) as avenues for finding future dividend growth. That helps give the ETF a quality tilt as it keeps the lineup away from financially leveraged companies that could be dividend cutters, but as Morningstar noted, favorable ROA and ROE data does not always guarantee dividend growth.

While that is a valid concern, there are some notable facts about DGRW, not the least of which being that although it is a dividend ETF, the fund also offers investors significant exposure to companies that are also voracious buyers of their own shares.

DGRW allocates nearly 40 percent of its combined weight to the consumer discretionary and technology sectors, the two sectors that have been the leading share repurchasers for several years. That is above average relative to other dividend ETFs, but that overweight also indicates DGRW is capturing sector that have recently been and can continue to be sources of significant payout growth.

“Dividend-payout rates are a good indicator of dividend safety and growth potential. Lower payout rates usually indicate that a firm is reinvesting a larger portion of its earnings in the business to fuel growth. (This may not be the case if the firm has a large share-buyback program.) They also suggest that the firm has a larger cushion to protect its dividend payments if its earnings dry up. At the end of March 2016, the average payout rate of the fund's holdings was 0.51, a bit higher than the corresponding figure for the S&P 500 (0.41), based on forward-looking data,” added Morningstar.

Disclosure: Todd Shriber owns shares of DGRW.