Neena Mishra: Dividend ETFs had seen a lot of interest in the past 2-3 years as investors searched for yield in the ultra-low interest environment. They fell out of favor for some time after the taper talk resulted in interest rates inching higher.
However as investors are now getting concerned about growth pace of the economy and corporate earnings, dividend ETFs are back in focus.
Dividends Triumph over Long Term
Dividends have accounted for more than 40% of total market returns over a long time horizon (over the past 80 years). Further, since early 1970s, S&P 500 dividend growth has outpaced inflation by 100% and by almost eight times since 2010.
At the same time, since most dividend paying companies are stable, mature companies with solid cash flows these investments provide greater stability and safety in a volatile environment and the markets are expected to continue to be volatile this year.
Dividends Continue to Grow at Record Pace
US companies continue to increase their dividends. 2013 was the fourth consecutive year of double-digit dividend growth, after decline seen during 2007-2009. Further, dividend increases continued their strong trend during Q1 2014.
Looking at sectors, all sectors excluding financials have recorded an impressive 56% growth in the dividend stream since 2007, thanks mainly to a massive 221% surge in technology sector dividends.
Per FactSet Dividend Quarterly, financial sector is now expected to lead the dividend growth, with 17.7% DPS growth estimate in 2014 and 15.1% in 2015. The surge in dividends is a result of capital plans approval of 25 major US banks by the Fed. (Read: 3 Financial ETFs o play the bank stress tests)
Overall, dividends are expected to grow 9.9% in 2014. Most large companies have huge cash piles on their balance sheet and are in a position to increase payouts to shareholders. Further, despite recent increases, dividend payout rates are still quite low (~36%) compared to their historical average of 52%, per S&P Dow Jones.
High Quality or High Yield?
In my view, ETFs that hold stocks with high dividend growth potential are much better for long-term investing than ETFs that focus on high dividend yielding stocks. These stocks may not be paying a huge yield now but they generally have a solid growth potential.
According to a study based on the performance of both high yielding and dividend growth stocks, over the past 85 years, dividend growth should provide about 7% average annual return over the next decade while high yield stocks will return only about half as much during the same period. Further dividend-growth companies also look more attractive in terms of valuation.
Stable, cash-rich companies that have a consistent record of increasing their dividends have outperformed the boarder market over the longer-term.