How exciting is it to hold a dividend paying ETF of 2.52% like SPDR S&P Dividend (SDY), when Treasury yields are 2.49%? Will corporate American increase yield to make dividends more enticing?
“We absolutely do think that corporate dividends will keep up with the Fed,” says Eric Ervin, CEO of Reality Shares, a dividend focused ETF company.
Dividends in the S&P 500 have risen 41 of the last 44 years and have grown nearly 6.5% per year over the same period. Performance is in line with the equity market, in which there have been 62 bull years and 54 bear years since 1900. Corporations often increase dividend payouts during bull markets which everyone knows leads to higher total return. Ervin says that even with Fed hiking this year, a diversified portfolio dividend paying growth stocks, even if that dividend is equal to Treasury yields, has way more upside than fixed income.
For example, SDY is up 58.9% over the last five years, while the iShares 3-7 year Treasury ETF (IEI 114,79 -0,47 -0,41%) is up 0.39% and the iShares 10 Year (IEF 93,14 -0,62 -0,66%) bond fund ETF is down 0.1%. Over the last 10 years, since March 9, 2007, SDY rose 43.39% while IEI rose 21.1% and IEF rose 25.12%. And this was in a bond bull market. Year-to-date, the Reality Shares Divs ETF (DIVY 26,48 +0,04 +0,13%) rose 5.78%, beating all three of those aforementioned funds by at least 200 basis points.
Reality Shares constructs their ETFs to capture long and short themes on dividend paying stocks. DIVY, for instance, is for long term capital appreciation based on the growth of large-cap dividends, not the growth of the stock price.
“Investors need to consider quality dividend-growing stocks versus simply high-yielding stocks,” he tells us. Dividend-growing stocks have historically outperformed dividend maintainers, dividend cutters and non-dividend payers in the S&P 500 since the early 1970s. Reality Shares’ Dividend Leaders Fund (LEAD 64,99 +0,15 +0,24%) is long companies that are increasing payouts. Their holdings have yields under 2%, but the underlying story of the stock is growth.
With BB bonds yielding over 5% in dollars, and safe haven Treasurys on the rise, will dividend stock funds lose their lure?
Over the last week at least, the dividend index fund (SDY 129,25 +0,24 +0,19%) has been outperforming the S&P 500. Many dividend-growth stocks are currently undervalued as investors bet they go out of favor in a Fed tightening cycle.
Dividend growers have historically traded at a 23% premium to high-yielding stocks (from February 1983 through December 2016), but are currently trading at a 9% discount to high-yielding stocks.
Reality Shares’ proprietary analysis model, known as their DIVCON methodology, is the crystal ball for this young firm. Across the dividend-investing spectrum, virtually all dividend-based strategies use rear-view mirror results as an indicator of future dividend growth. DIVCON is a forward-looking strategy that predicts and ranks a company’s ability to increase or decrease its future payout by evaluating each firm based on seven quantitative factors. If their crystal ball is right, they can more or less judge which companies will increase payouts, or raise their dividend yield, and allocate accordingly.
Ervin makes his case in simple terms here: “High-quality dividend stocks that continue to grow their dividends should be attractive to investors regardless of market environment,” he says.