VIG - DGRO: An Impressive Option For Growing A Dividend Stream

2023-04-17 03:14:53 ET

Summary

• Dividend investors with a long time horizon should focus on the amount of dividend growth their portfolios offer.
• High yields off the bat will sometimes fail to provide better long-term income.
• The iShares Core Dividend Growth ETF is a solid option for those looking to grow their dividend income over time.

When it comes to investing, few things are as exciting as receiving dividends. Outside of getting in on the ground floor of a hot growth stock, few things will pay off as well as a growing stream of dividend income.

As a guy who's getting closer to the end of my career than its beginning, I'm focused on dividend income that I can use to invest in more shares. I don't have more than 15-20 years in the workforce to bank on dividend growth. I have some funds and individual stocks that have relatively high yields, but I do also have a few with relatively low yields that have shown a propensity to grow rapidly. They just don't make up the majority of my portfolio.

If I were in my 20s, I'd probably switch my strategy and focus on investing in dividend payers that are more likely to pay a smaller dividend in the present with higher growth potential over time. Stocks like Visa ( V ) and Lowe's ( LOW ) come to mind. I own the latter, but it's one of the few companies I hold with a dividend in the 2% range.

Over the past five years, Lowe's has grown its dividend by 20% annually. A company with this level of dividend growth would see the dividend double in approximately 3.5 years. Therefore, a $1 per share dividend in year one might grow to a dividend of $8 within a decade. In other words, $1,000 in dividend income could turn into $8,000 in about 10 years.

Few companies are able to keep this record up for decades, but a 5-10% dividend growth rate over the long run is possible. Johnson & Johnson ( JNJ ) has grown its dividend for 60 years, and it's still increased the dividend by more than 6% on average over the past five years. The dividend would double every 12 years, compared with every 3.5 years that's evident with Lowe's recent record. Both are great companies with solid records of providing cash flow for investors, but one has slowed down its dividend growth.

Lowe's is actually a major outlier here--it's grown its dividend for 59 straight years, but still has a massive level of dividend growth in recent years. JNJ is much more common among companies with such a long record of dividend growth.

DGRO vs. VIG

Those looking to get a decent entry yield with some solid growth might check out the iShares Core Dividend Growth ETF ( DGRO ). A popular ETF that might compare favorably is the Vanguard Dividend Appreciation ETF ( VIG ). Both of these funds have a similar strategy: paying a stream of dividends that grows at a healthy rate over time.

DGRO is not an old fund. Therefore, its record is not as long as many funds that are currently on the market. The fund's inception only occurred in June 2014. However, its five-year CAGR is a solid 10.71%. This would cause shares to double, on average, in a little less than seven years, and it compares very well to VIG's five-year average return of 10.88%.

iShares currently lists 449 holdings on the DGRO home page . This is a high level of diversification that exceeds that of VIG, one of its biggest competitors. The latter holds 289 stocks, as noted on Vanguard's page that covers VIG. DGRO is also diversified into a wide range of sectors, with the largest concentration of its invested capital going toward companies in the health care sector.

Financials and IT companies also make up a large percentage of DGRO's allocation. Health care and IT companies tend to be involved in the more innovative sectors of the economy, and this frequently brings rapid growth for the companies that perform well.

Both funds offer a dividend that's higher than the broader market, which is currently around 1.6% . However, the dividend and the dividend growth are really where DGRO shines.

The yield for DGRO as of March 31, 2023 was 2.49%. This compared very favorably to the 1.89% yield offered by Vanguard's Dividend Appreciation fund. Indeed, this is a substantial difference that could lead to a major divergence in dividend income if the growth is similar for both funds as the higher yield compounds more rapidly. Two of the top 10 holdings for VIG are Visa and Mastercard ( MA ), both of which have a sub-1% yield. Both combined make up a little more than 1% of DGRO's asset allocation, whereas they constitute nearly 5% of VIG's holdings.

Despite these two companies with rapid dividend growth taking up more of VIG's investment capital, over the past five years (keep in mind that DGRO does not yet have a record that reaches 10 years), DGRO has grown its overall dividend more rapidly than has VIG: 10.32% to 9.87%. This higher level of dividend growth will also cause the dividend payout to diverge over time as the difference in the growth that's starting from a higher base continues to compound.

Conclusion

Those looking for a solid dividend growth ETF might consider DGRO over VIG, despite the latter's strong record that is longer. DGRO has a solid yield that's close to 2.5%, nearly a full percent higher than the yield offered by the S&P 500 ( SPY ) as a whole. It's also 60 basis points higher than one of its main competitors in the dividend growth ETF space. Furthermore, if DGRO can maintain its current level of dividend growth, investors might expect to see its payout double approximately every seven years.

Therefore, a 30-year-old who has managed to invest $40,000 in DGRO would have an annual income of $1,000 today from this holding. In 35 years, when today's 30-year-old hits a common retirement age of 65, that $1,000 in income might reasonably be expected to turn into $32,000 if the current level of dividend growth continues. This is not a guarantee by any stretch, as past returns do not ensure future success, but it is within the realm of possibility as new companies come into the market and start off with low, but growing yields. An annual dividend income of $32,000 will likely not pay for an entire year's expenses, but it would definitely pay for many of them. That's likely the biggest benefit of growing dividend income over time.

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