Income investors often focus on the wrong value metrics for their portfolio. A properly designed dividend growth strategy can get you back on track without sacrificing attractive yields.
Dividend strategies have permeated the markets over the past decade, as investors placed a large premium on attractive yields. Naturally, this attitude created strong demand for traditional high dividend payers, and they, in turn, have outperformed the market. However, the fallout from the low-interest-rate environment has left many of these large-cap companies holding excessive debt, a reality that could undermine their dividend payout strategy.
Rather than focus on stocks with the highest yield, nuanced investors have shifted their attention to companies with an established history of dividend growth. After all, companies with decades of steady dividend payouts offer the reliability that some of the high dividend payers can’t match. This is true regardless of company size and works just as well for small- and mid-cap stocks as it does for domestic large-cap players.
Allocating a greater share of your portfolio to companies that have sustainable and growing dividends is the centerpiece of a dividend growth strategy. A portfolio with such an allocation offers protection against volatility and the prevailing risks tied to rising interest rates and slowing economic growth. A successful dividend growth strategy doesn’t let sector or company size limit its asset selection. Instead, it places a premium on value metrics tied to a stock’s fundamentals.
Use the Dividend Screener to find high-quality dividend stocks. You can even screen stocks with DARS ratings above a certain threshold.
Putting Dividend Growth Strategy Into Action
A successful dividend growth strategy should focus on quality over quantity – that is, investors should seek out value stocks with an established track record of dividend payouts and strong fundamentals. They should also have a long-term investment horizon that allows them to reinvest earnings at regular intervals. This is key to long-term growth and sustainability in any market cycle.
Below are three factors that investors should consider when putting their strategy into action.
Be sure to check here for the differences between dividend growth and total return.
Rely on Sector Fundamentals
Sector diversification is an important part of a successful investment strategy, and it is duly important for dividend earnings. Whereas simple dividend strategies focus purely on yield, a growth strategy likes to be more diversified across sectors. This ensures that you can continue to run a profitable portfolio of stocks during periods of volatility and rising interest rates.
While simple dividend strategies usually entail loading up on utilities, consumer staples and financial companies, dividend growth strategy looks at sector fundamentals and companies with quality balance sheets.
Focus on Dividend Growth Leaders
Since dividends are generated from a stock’s underlying earnings, dividend activity is a much better proxy for company performance than the size of the yield. That’s why factors such as free cash flow, buybacks and earnings forecasts are so critical in your selection of dividend stocks. These factors also ensure that the company is well positioned to increase its payouts in the future. High yields do not offer that protection.
Dividend growth leaders also tend to increase their payouts at a faster rate than inflation, which adds real value to your portfolio. The Federal Reserve targets inflation at 2% annually and recent metrics suggest price growth is exceeding that target. Stocks that increase their payouts at a faster clip should be prioritized.
Stocks that fit the above criteria include Walmart Stores Inc. (WMT ), McDonald’s Corporation (MCD ) and Walgreens Boots Alliance Inc. (WBA ). All three companies are part of the Dow Jones Industrial Average, yield more than 2% annually and have grown their payouts for more than four decades.
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Opt for ETFs Focussed on Custom Dividend Strategies
Investors shouldn’t stop there, as selecting companies with a long payout history may not be enough to address things like inflation and sector fundamentals. At the same time, yield could merely reflect a stock’s recent decline.
To combat some of these risks, investors should consider exchange-traded funds (ETFs) that specialize in dividend growth. Chief among them are the WisdomTree U.S. Dividend Growth ETF (DGRW), which can be used to complement existing dividend strategies, and the Vanguard Dividend Appreciation ETF (VIG), which provides an easy way to gain exposure to dividend growers without being overly exposed to one single company.
The Bottom Line
Investors chase dividend yields at their own peril. A more successful strategy prioritizes sustainable growth, protection and asset diversification. These factors are captured by the dividend growth strategy.
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