VIG - DGRO And VIG: Which Is The Better Buy?

2023-12-27 11:35:47 ET

Summary

• DGRO and VIG are similar ETFs with low expense ratios, a large amount of assets under management, and a focus on dividend growth stocks.
• VIG focuses on large companies that have consistent payout growth, while DGRO focuses on top, profitable dividend stocks with room to grow distributions.
• DGRO has outperformed VIG in terms of total returns and yield on cost since inception.
• We prefer DGRO for the long term, and we think you should too.

At first glance, Vanguard Dividend Appreciation Index Fund ( VIG ) and iShares Core Dividend Growth ETF ( DGRO ) are quite similar ETF's. Both funds invest into dividend growth stocks, sport a low expense ratio, and have billions of assets under management.

However, when you dig a little deeper, some important differences begin to emerge - differences that may affect your long term returns substantially.

Today, we'll break down the differences between these two popular funds and give our take on which ETF deserves a spot in your income portfolio.

Sound good? Let's jump in.

Similarities Between DGRO and VIG

As we just mentioned, there are a lot of similarities between these two popular dividend growth ETF's.

Firstly, the expense ratios of both funds are quite low. DGRO charges an annual fee of 0.08%, and VIG charges an annual fee of 0.06%. While VIG does have the advantage here, both ratios are extremely low and should have a minimal impact on long term returns.

For example, over 10 years, on a $10,000 investment, an investor in VIG could expect to pay $77 in fees. Alternatively, an investor in DGRO could expect to pay $103 in fees. These assumptions are based on annual returns of 5% per year and a stable fee structure. Clearly, this is a small difference and shouldn't factor into your decision-making framework as to which may produce better long-term net total returns.

In addition to sporting a similar fee structure, both funds have large pools of assets under management. This doesn't have a big impact on investment returns, but it does indicate the level of liquidity available in the open market for shares when it comes to getting in and out of a position. In short, both ETFs are highly liquid and should prove very low cost to hold, as well as get in and out of.

Finally, and perhaps most obviously, both DGRO and VIG have very similar stated goals when it comes to investing - to invest in the best dividend growth stocks around.

But which is the better buy?

Differences Between DGRO and VIG

The key differences begin to show up once you look more deeply into each fund's strategy for investing in dividend growth stocks.

VIG, the larger ETF, does things very simply. It starts with the universe of all dividend paying companies, and then screens for stocks that have been paying dividends for 10 years or more, consecutively. Then, it invests in the top quartile of stocks based on yield. Finally, it weights positions based on Market Cap.

It has inherited this decision making & strategy from the index it follows, the S&P U.S. Dividend Growers Index.

So, functionally;

VIG = (Stocks with >10 years of consecutive dividend raises) + (The top 25% in terms of yield) + (market cap weighted).

Practically, this has resulted in a somewhat concentrated holdings structure, with the top 10 holdings making up more than 32% of the portfolio, and a strong bias towards Technology ( XLK ) and Financials ( XLF ) exposure:

This differs substantially from DGRO, which has a slightly more sophisticated way of selecting securities for its portfolio :

Following the Morningstar® U.S. Dividend Growth Index, DGRO first screens out a number of securities it's not looking to invest in, like REITs.

Then, it screens further for at least 5 years of consecutive dividend growth, a positive consensus earnings forecast, as well as a sub-75% payout ratio.

Then, instead of market cap weighting the holdings, it weights them by dividend payments, up to a cap of 3% per position.

In sum;

DGRO = (Stocks with >5 years of consecutive dividend raises) + (positive consensus earnings expectations) + (Under 75% payout ratio) + (Total dividend payout weighted).

In real terms, this has resulted in a much different looking portfolio than VIG, with a lower level of concentration, more total positions, and less focus on Technology & Financials:

Overall, when comparing the two ETFs, the differences are clear. VIG focuses on large companies that pay consistent, growing dividends.

DGRO focuses on diversification among the top, profitable dividend stocks that have room to grow their payouts even more.

Historical Performance & Context

For our money, we prefer the latter option.

DGRO's focus on top dividend payers and limiting the weighting of positions not only makes sense on paper, but has also outperformed VIG's strategy when it comes to total returns:

It's true - the differences haven't been large. Plus, the simplicity of VIG's strategy initially actually appears to be attractive.

However, DGRO's payout ratio cap and profitability screen has allowed holdings to increase payouts more over the last few years, which is clearly shown in the 100+ basis point difference between VIG and DGRO in yield on cost since inception.

Here's where VIG's YoC is since June 2014:

And here is DGRO over that same period of time:

Clearly, DGRO has done a better job of mechanically selecting assets that grow payouts over time.

The difference in total returns since 2015 is small, which may have some investors thinking that it may not be worth switching from VIG to DGRO for the time being.

However - when you really break it down; what is the purpose of a dividend growth investment?

Investing now, growing the pot, then living off of the dividends.

On both an income and total returns basis, DGRO seems to be accomplishing its dividend growth goals better than VIG.

Stronger total returns until retirement, and then better yield for the cash invested once you get there.

What might this look like going forward?

While DGRO does have stronger total returns than VIG since inception, if you're not re-investing the principal, then VIG's price appreciation has been more robust, if only by a small margin:

However, as long as you're re-investing distributions into DGRO, then it's likely that in retirement you'll see a stronger level of income given the dynamics we've already discussed.

On the valuation front, DGRO also looks slightly more attractive. When looking at the top positions in each fund, there are some similarities, but DGRO's holdings are cheaper, on average:

If you do a more complex calculation and weight these top 10 positions as each ETF has, as opposed to a simple average, then DGRO appears even an even better relative value.

Plus, in today's market environment , DGRO's minimal tech weighting (relative to VIG) appears to be set to fuel further outperformance in the foreseeable future.

Risks

There are some risks to holding each of these ETFs, similar to those you would find in holding any diversified basket of stocks; mainly Market risk.

Sector risk and Single Stock risk are significantly reduced as a result of the fund's diversified portfolio of holdings, but VIG and DGRO investors still have exposure to big market moves that affect all equities.

That said, dividend growth strategies have typically done better over time in the risk department than the S&P 500. Have a look at the largest drawdowns that VIG has seen over the last few decades:

This compares favorably with a strategy that simply holds the S&P 500, where similar market drawdowns are larger and deeper:

All in all, these dividend growth strategies should be seen as a lower risk strategy than the S&P 500, but one that still carries some risk as a result of the all-stock composition of the portfolio.

Summary

Net net, we prefer DGRO to VIG, despite the slightly higher expense ratio and more complex strategy.

The fund's returns speak for themselves, and the key differences in how the ETFs select their holdings have us thinking that DGRO is better positioned to perform as a solid dividend growth investment over the long term.

Therefore, we rate DGRO a "Buy", and VIG a "Hold".

Cheers!

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