A Dividend Growth Fund That Simply Prints Money

As if the threat of a coming correction isn’t bad enough, income investors must adapt to a world of slowing dividend growth. According to S&P Dow Jones Indices, dividend net increases came in at $6.7 billion in the second quarter of 2017, a decline of 7.9% from the same period a year ago, when they came in at $7.3 billion.

Investors accustomed to the market pumping out annual double-digit dividend growth since 2011 are frustrated as consensus projections call for single digit growth over the next three years. But you don’t have to settle for less.

Below, I highlight a simple and easy way to tap robust dividend growth. It’s an exchange-traded fund (ETF) that throws off a reliable stream of growing income, by picking the highest-quality dividend growth stocks for its portfolio.

First, let’s discuss the power of dividend growth and why under today’s uncertain investment conditions it’s more important than ever.

Dying on euphoria…

August is shaping up to be a challenging month for investors. The major indices closed essentially flat on Monday, following back-to-back losses the last two weeks. As the dog days of summer unfold, nervous bulls are finding little reason to leave the sidelines.

In the words of legendary investment guru Sir John Templeton: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

It’s safe to say that the bloom is off the post-election euphoria. With stocks climbing to record highs after Donald Trump’s surprising election, investors are now concerned that his promises of tax reductions and greater infrastructure spending will meet the same fate as the GOP’s failed efforts in July to repeal and replace Obamacare.

Meanwhile, a key factor behind the downward trend of dividend growth is the U.S. Federal Reserve’s tightening of the monetary spigot.

The nearly decade-long era of ultra-low interest rates has been beneficial for dividend-paying stocks. Not only could they often offer payouts greater than the yield on 10-year Treasuries, but they also racked up spectacular share price appreciation.

However, income-oriented investors now face a changing backdrop. Rising bond yields are surpassing the payout levels of many dividend producers. To stay ahead of the curve, you need to focus on exceptional firms that have a long history of rising dividends — in any economic climate.

Fact is, rising rates tend to push up government bond yields, which makes dividend-paying stocks as a whole less attractive from a risk-to-reward standpoint. The benchmark 10-year Treasury currently stands at 2.19%:

10-Year Treasury Rate

Source: Multpl.com

You can see the effect of rising bond yields on the S&P 500’s dividend yield:

S&P 500 Dividend Yield

Source: Multpl.com

The S&P 500 currently sports a yield of 1.95%, below the yield of the 10-year Treasury.

Consider yourself warned: Rising interest rates will likely devastate scores of overly leveraged, slow-growth companies with unsustainably high dividends.

But you can still find suitable high-dividend opportunities, if you apply the right criteria and know where to look. What’s more, with most analysts calling for a market downturn this year, one of the best defensive growth strategies is to choose companies with strong and rising dividends.

You don’t have to be an income investor to love dividend-paying stocks. Dividend-payers are time-proven vehicles for long-term wealth building, but they’re also safe harbors in turbulent seas because companies with robust and rising dividends by definition boast the strongest fundamentals.

If a company has the low debt and healthy cash flow required to throw off juicy dividends, it follows that the balance sheet is intrinsically sound enough to sustain the company through market corrections.

That’s why stocks with growing dividends are particularly appealing right now to both income and growth investors. What’s more, research shows that dividend growers outperform high-dividend yielders in the early stages of Federal Reserve tightening cycles.

Think of dividend growth investing as a total return-focused equity strategy with a defensive bias. But here’s the challenge: it’s one thing to find a growing yield; it’s another to find one that’s sustainable.

Planting seeds of wealth…

Here’s a safe dividend growth alternative with a proven track record: the WisdomTree U.S. Quality Dividend Growth Fund (NSDQ: DGRW). With net assets of $1.68 billion and a current dividend yield of 1.89%, this fund seeks to track the investment results of dividend-paying large-cap companies that also boast growth trajectories.

The fund’s strategy emphasizes long-term profit growth over outsized dividend yields. Among the roughly 1,500 dividend-paying stocks in existence, WisdomTree U.S. Quality Dividend Growth Fund first screens for companies with a minimum market cap of $2 billion (although most are above $10 billion) and a dividend coverage ratio greater than 1.

From that pool of investable companies, DGRW pinpoints companies with healthy earnings expectations, return on assets and return on equity. DGRW also emphasizes businesses that consistently generate free cash flow and maintain conservative balance sheets. The management of these dividend-paying companies must be efficient, with capital allocation policies that generate both a high dividend payout ratio and solid growth.

DGRW generated a total return of 4.09% in the second quarter, 12.57% year to date, 15.62% over the past year, 11.36% over the past three years, and 12.53% since inception on May 17, 2013. The expense ratio is a low 0.28%.

The fund’s holdings represent the cream of blue-chip dividend payers, with about 300 stocks spread across diverse sectors. The top five holdings are Johnson & Johnson (NYSE: JNJ), Apple (NSDQ: AAPL), Microsoft (NSDQ: MSFT), Pepsico (NYSE: PEP), and AbbVie (NYSE: ABBV), cumulatively accounting for 20.22% of assets.

DGRW’s top five fund sector weights are information technology (19.80%), health care (19.70%), industrials (18.86%), consumer discretionary (17.36%), and consumer staples (14.94%).

During this protracted bull market, many investors have done well by owning dividend stocks that got bid up because of low interest rates. However, amid rising interest rates and excessive equity valuations, dividend paying stocks are increasingly at risk.

Chasing yields can lead to catastrophe. Buying quality dividend growers is a safer path to income as well as market outperformance. DGRW provides an inexpensive, low-maintenance way of pursuing this strategy.