RDVY - 3 Quality Dividend Growth ETFs For Maximal Total Returns

2023-09-01 07:30:00 ET

Summary

• Dividend growth investing is a great strategy for long-term investors, offering compounding from reinvestment, dividend growth, and stock price appreciation.
• The best dividend growth stocks and ETFs tend to have a quality tilt, picking companies with sustainable competitive advantages and growth capabilities.
• I highlight three dividend growth ETFs with a history of beating the market in total returns and discuss what makes them each unique in their own ways.

Dividend growth investing ("DGI") is a great form of investing for long-term investors, especially younger investors with decades until their expected retirement.

It offers multiple channels of steady compounding from reinvestment of dividends, strong dividend growth, and stock price appreciation.

Almost by definition, the best DGI stocks with the best dividend growth track records are high-quality companies with sustainable competitive advantages and growth capabilities. Thus, the best DGI stock-picking strategies and ETFs tend to also have an explicit or implicit quality tilt.

Here's what I generally look for in a dividend growth stock or ETF:

• Highest dividend growth
• Consistent level of dividend growth over time
• Best combination of starting yield and dividend growth rate

Total returns tend to matter to me less, because my ultimate goal as a DGIer is to generate a passive income stream from dividends that is large and safe enough to cover my desired expenses without ever needing to sell shares. To me, true financial freedom comes from passive income, not from some level of net worth.

Since passive income is my ultimate goal, stock price appreciation is not my primary concern.

However , even for someone who wants to retire on dividends, total returns (including stock price appreciation) remain an important consideration, for multiple reasons:

1. Higher total returns over time is a signal of company quality
2. Higher total returns almost always accompany strong and steady dividend growth
3. Higher total returns result in a larger portfolio value, which gives an investor optionality

What kind of optionality am I referring to in that last point? Well, with more gains and a larger portfolio value, an investor can eventually trim or sell big winners that sport low dividend yields in order to reinvest in higher yielding names to bump up their total dividend income prior to retirement.

Alternatively, with more gains and a larger portfolio value, an investor can retire on a combination of dividend income and equity sales.

In any case, high stock price appreciation and total returns is rarely, if ever, a bad thing.

As such, let's look at a handful of dividend growth ETFs that specifically aim for maximal total returns (as well as high dividend growth) to compare and contrast them.

Comparing The Dividend Growth ETFs

The ETFs we'll be comparing in this article are:

• iShares Core Dividend Growth ETF ( DGRO )
• WisdomTree U.S. Dividend Growth ETF ( DGRW )
• First Trust Value Line Dividend ETF ( FVD )
• Siren DIVCON Leaders Dividend ETF ( LEAD )
• FlexShares Quality Dividend Defensive ETF ( QDEF )
• FlexShares Quality Dividend ETF ( QDF )
• First Trust Rising Dividend Achievers ETF ( RDVY )
• Schwab U.S. Dividend Equity ETF ( SCHD )
• Vanguard Dividend Appreciation ETF ( VIG )

Compare these to the S&P 500's ( SPY ) annual dividend growth metrics averaging 6% over the last five years and 7% over the last 10 years. Also, currently, the SPY offers a dividend yield right around 1.5%.

My favorite dividend growth ETF is SCHD. I explained why in " Why SCHD Is A Dividend Growth Investor's Dream ETF ." It offers a fantastic combination of relatively high dividend yield (over 2x higher than SPY) and strong, consistent dividend growth.

But DGRW and RDVY also boast double-digit dividend growth track records, while LEAD's shorter dividend growth record is also highly impressive, if a bit lumpy.

Speaking of lumpy dividend growth, I am going to go ahead and disqualify QDEF and QDF because of their lumpy and inconsistent dividend growth.

Having 7% annual dividend growth over 10 years sounds decent, but 1% over the last 5 years indicates quite the inconsistency.

Moreover, both of these ETFs have significantly underperformed the market over time, especially over the last five years.

To be fair, I have not performed deep dives on these ETFs, and they may be more worthy of consideration than I'm giving them credit for, but I prefer greater dividend consistency. And the total returns have been uninspiring for low-yielding ETFs.

As for the rest of the group, let's look at an admittedly busy chart showing total returns against SPY for as long as each of them has been publicly traded:

As you can see, three of these dividend growth ETFs beat the market, while four do not.

Here are the total returns of those four underperformers against SPY on a somewhat longer timeframe:

Aside from VIG, these ETFs generally have dividend yields in the 2-3.5% range, a good bit higher than SPY's 1.5%. DGRO comes the closest to matching SPY's total returns, while FVD is the furthest, perhaps due to its slight value tilt and emphasis on utilities (20%+ of the portfolio).

As for the three outperformers, we do not see dramatic outperformance over SPY, but the outperformance isn't negligible either.

Without exception, these three ETFs are lower-yielding, with RDVY offering the highest yield of about 2% and LEAD the lowest at about 1.15%.

Let's peer under the hood of these three ETFs to see what their secret sauce to high total returns might be.

1. WisdomTree U.S. Quality Dividend Growth ETF ( DGRW )

DGRW tracks the WisdomTree US Quality Dividend Growth Index , which starts with an investable universe of large cap ($2 billion+ market cap) dividend payers. It screens for the 300 best stocks in terms of various growth and quality factors. To quote the index webpage:

The growth factor ranking is based on long-term earnings growth expectations, while the quality factor ranking is based on three year historical averages for return on equity and return on assets.

Finally, these 300 stocks are dividend-weighted. Not dividend yield -weighted, mind you, but weighted by aggregate cash dividends. This naturally favors bigger companies like Microsoft ( MSFT ), Apple ( AAPL ), and Broadcom ( AVGO ), currently the top three holdings, over smaller companies. But in theory, you could have two companies of equal market cap, but one pays a larger aggregate dividend than the other and therefore the former has a larger weighting in the index.

In my opinion, it is the combination of DGRW's quality and forward-looking growth expectations filters that provides the special sauce. High-quality companies with strong growth prospects tend to outperform the market, and they typically do so while growing their dividends at above-average rates.

With an expense ratio of 0.28%, DGRW does not have the lowest fees for a passive ETF, but they are modest.

2. Siren DIVCON Leaders Dividend ETF ( LEAD )

LEAD tracks an index created by Reality Shares called the Siren Dividend Leaders Index. The index uses a proprietary quantitative system called " DIVCON Dividend Health Scoring " that features a "uniquely forward-looking" methodology to pick stocks.

This system considers 7 quantitative metrics to rank dividend-paying stocks in the S&P 500 by dividend safety and likelihood to grow, separating them into quintiles. DIVCON 1 stocks are least likely to grow their dividends and most likely to cut them. DIVCON 5 stocks are those deemed most likely to grow their dividends in the next twelve months.

According to the ETF sponsor Siren ETFs , LEAD invests in "only the anticipated dividend growth leaders, the large-cap companies with the highest probability of increasing their dividend in the next 12 months."

The index (and LEAD) include all DIVCON 5 stocks, or the 30 highest ranking stocks in the DIVCON system (dipping into DIVCON 4 territory if needed), whichever is higher. So, LEAD will always hold at least 30 stocks.

LEAD is overwhelmingly weighted toward technology (37%), industrials (25%), and healthcare (12%) stocks. Currently, its top three holdings are Broadcom, Lam Research ( LRCX ), and Old Dominion Freight Line ( ODFL ).

Given its status as a highly specialized and proprietary index fund, LEAD's expense ratio of 0.43% strikes me as fair.

3. First Trust Rising Dividend Achievers ETF ( RDVY )

RDVY tracks the Nasdaq US Rising Dividend Achievers Index . This index screens for US companies with both EPS and dividends higher today than the past three and five years, but then the formula does something interesting.

The next filter targets companies within this group of stocks with cash-to-debt ratios greater than 50%. This basically picks stocks with either a high level of cash or a low level of debt, or both. Finally, RDVY filters out any stocks with payout ratios higher than 65% as a further tilt toward conservatism.

The index weights constituents by a combination of three factors:

• Dividend growth rate over the past five years (the higher the better)
• Dividend yield (the higher the better)
• Payout ratio (the lower the better)

Based on these criteria, the index picks the 50 best stocks, and no sector is allowed to make up more than 30% of the total.

RDVY's top three sectors by weighting are financials (30%), industrials (15.7%), and energy (12.8%). Currently, its top holdings are Civitas Resources ( CIVI ), MGIC Investment Corporation ( MTG ), and Comerica ( CMA ).

I find RDVY's methodology to be very unique and appealing. Its filters screen for relative conservatism in its stock holdings, and its weighting system rewards companies with the most attractive dividend metrics.

To be fair, though, RDVY has not outperformed SPY over every measurement period. For instance, since its inception date in 2014, RDVY has slightly underperformed SPY.

RDVY's expense ratio of 0.50% strikes me as a touch higher than it could be, but the strategy and methodology is undeniably unique and makes for a good complement to other core dividend growth ETF holdings.

That said, RDVY does appear to skew toward some slightly higher risk industries/sectors that could cause it to underperform during downturns and outperform during bull runs. The minimal exposure to technology, however, does give it a bit more of a value tilt than a growth tilt.

Bottom Line

There's a world of variety in the ETF space. Smart people in the financial industry have thought of myriad ways to slice and dice the stock market into whatever specific type of investing souffle you might like.

I find SCHD an excellent all-around choice for dividend investors, combining above-average yield with a quality tilt, strong appreciation, and high dividend growth. In fact, its combination of yield and dividend growth is, in my estimation, the best in the ETF space for DGIers.

However, for those primarily interested in long-term appreciation and market-beating total returns, DGRW, LEAD, and RDVY appear to be great choices for further research.

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