Apple (Nadaq: $AAPL) made headlines this week by announcing that, at long last, the company would start paying a dividend. This is fantastic news, not just for the Apple shareholders that had been agitating for the change, but for the broader investing public. Apple is one of the most closely watched and admired companies in the world; perhaps other technology companies (ahem…Google?) will follow Apple’s lead and start moving in the direction of shareholder friendliness.
Don’t get me started on Google, by the way. That company has a rare talent for pouring shareholder cash down the drain on quixotic pet projects that add little to revenues and even less to profits. None of this would be possible were it not for the gargantuan monopoly-like rents that the company is able to collect on its search franchise. The responsibility of paying a dividend might force Google to grow up and be an adult company befitting its size and importance to global economy rather than continue as a spoiled adolescent with too much money. But I digress…
In the case of Apple, it was about time. With $100 billion in cash sitting on the company’s balance sheet more or less inert, Apple was doing a real disservice to its long-term shareholders.
And herein lies a key point: long-term. The growing popularity of dividends in recent years may be the most positive development in the capital markets in my lifetime. It’s a return to a more sober, rigorous form of investing that favors stable, long-term returns. It takes away the casino gambling mentality and replaces it with something far more constructive.
Money managers of my generation grew up in the hot-money, high-turnover markets of the late 1980s and 1990s, a period that saw the average holding period of a stock investment shrink from years to just months. In this kind of market, the payment of a quarterly cash dividend seemed almost anachronistic. Besides, dividends were taxed more heavily than capital gains, so why not use the cash for share buybacks? The market always rises, after all.
It is amazing how two bear markets and twelve years of P/E multiple contraction will change investors’ thinking. Part of this too is the math of demographics. The same Baby Boomers that were aggressively investing for growth a decade ago are now at a different stage of their lives. Income is now far more important than it was before, particularly given the poor yields on offer on the bond market. As the largest and richest generation, the investment preferences of the Boomer become the de facto standard.
With all of this as an introduction, I’d like to leave readers with two ETF recommendations that focus on dividends. One focuses primarily on current income, the other on long-term growth.
We’ll start with current income. On this count, I consider the very first dividend-focused ETF to still be the best—the iShares Dow Jones Select Dividend ETF (NYSE: $DVY). DVY’s underlying index takes the universe of dividend-paying stocks with a positive dividend-per-share growth rate, a payout ratio of 60 percent or less, and at least a five year track record of dividend payment and then selects the 100 highest-yielding stocks. The result is an ETF loaded with high-yielding, reliable dividend payers.
Not surprisingly, DVY is heavily weighted in utilities and defensive consumer staples, currently 30 percent and 16 percent of the portfolio, respectively. The current dividend yield is 3.3 percent—significantly higher than what the 10-year Treasury pays.
As it is currently constructed, DVY is not likely to outperform the S&P 500 in a normal, rising market. It should, however, hold up far better during a market rout. (Looking back at the ETF’s history, DVY took a beating in 2008 because it had a high allocation to the financial sector at the time; today’s high allocation to more defensive sectors makes DVY far more conservative than it was five years ago.)
DVY is fine for current income. But if it is growth you seek, try shares of the Vanguard Dividend Appreciation ETF (NYSE: $VIG). At 2.0 percent, VIG yields far less than DVY, more or less in line with the broader S&P 500. But you don’t buy VIG for its dividend today; you buy it for its dividend tomorrow
VIG is based on the Dividend Achievers Select Index, which requires its constituents to have at least 10 consecutive years of rising dividends. Any stock currently in the portfolio raised its dividend during the crisis years of 2008 and 2009. These are companies that can survive Armageddon because, frankly, they already have.
Experienced investors can eschew the ETFs and cherry pick their own dividend-focused portfolios. A recent dividend payer like Apple will not be found in either ETF, and even a dividend-raising powerhouse like Apple’s rival Microsoft (Nasdaq: $MSFT) lacks the history to be included in the Vanguard ETF. I would be tempted to include both in a custom-built dividend portfolio.
Disclosures: DVY and MSFT are held by Sizemore Capital clients.