2023-10-20 11:40:10 ET
Summary
- The iShares Core Dividend Growth ETF shows 7% EPS growth and 5% DPS growth for YE24-YE25.
- Analysts predict a 12% upside potential for YE24 with a 2% dividend yield.
- However, it has not beaten the S&P 500 in the last 10 years.
Summary
The iShares Core Dividend Growth ETF (DGRO) as the name implies is focused on US stocks that have consistent dividend growth. This does not mean value stocks or high dividend yield stocks; it actually means companies that grow earnings above their investment (capex) needs and have excess cash flow (free cash flow) that can be distributed to shareholders via dividends or share buybacks. These are generally more mature companies with resilient business models yet have the ability to grow i.e., Blue Chips. However, this strategy has not beaten the S&P 500 (SPX).
In the analysis below I used consensus estimates for 75% of the portfolio (75 stocks) to derive EPS and DPS (dividend per share) growth, Yield, PE valuation and total return potential. I found that the DGRO portfolio has 12% upside, and a 2% dividend yield, and is trading at a PE of 12.5x with 7% EPS and 5% DPS growth respectively.
The ETF, adjusted for dividends, has not outperformed the S&P 500.
Price Appreciation vs. Dividends
DRGO is a diversified ETF with over 400 stocks across most sectors. However, the top 75 stocks represent 75% of the portfolio or on average 1% each. Microsoft ( MSFT ), JPMorgan Chase & Co. ( JPM ), Apple ( AAPL ), Exxon ( XOM ), Johnson & Johnson ( JNJ ) and AbbVie ( ABBV ) are the top 5 holdings with 17.3% weight. The following table has the consensus price target of each stock from which I calculated a weighted upside potential of 11.6% plus a 2.1% dividend yield. Clearly this fund is not for current income investors.
EPS Growth and Valuation
Before a company can increase its dividends, it should increase its earnings. Plus, given that the bulk of the potential return comes from EPS growth, I calculated the growth profile of the portfolio using consensus estimates. As can be seen in the following table; YE23 is not a great year with weighted EPS falling 2%, much of this is due to the extraordinary results in YE22 and a normalization of demand and margins. Analysts expect a stronger YE24 with 11% gain and 6% for YE25.
Valuation: While not compelling, it is not unreasonable relative to growth. I calculated a PE of 12.5x for YE24 and a PEG (PE to EPS Growth) of 1.4x. As a general rule a 1x PEG means a stock is fairly valued and the lower the ratio the less expensive the stock is relative to its earnings potential. Eli Lilly (LLY) is an outlier with very high EPS growth forecast, while many large banks, such as JPM, look challenged.
Dividend Growth
At the core of the fund's strategy is to select companies with high and consistent dividend growth. The data supports the rationale that companies with successful business models and capital discipline can reward shareholders with increasing dividends and obtain high valuations.
Using consensus estimates I calculated that the ETF has a long-term 6% DPS growth rate, almost the same as the EPS growth rate. This DPS does not always include share buybacks, thus the actual growth rate may be higher. Eli Lilly is again a standout as are Visa ( V ) and Mastercard ( MA ).
Total Return Potential
ETF could produce a total return of over 23% to YE25. Using consensus data, I calculated the implied PE target for each stock and applied that to YE25 EPS estimates to derive the YE25 potential upside. This I added to the estimated dividend yield to generate the total return. Note that in this exercise a gap emerged vs. weighted and average results. This suggests that the large caps may be detrimental to the portfolio. Outliers are NextEra Energy ( NEE ), Citigroup ( C ) and Target ( TGT ).
Conclusion
While DGRO appears to have a solid strategy that identifies consistent earnings growth and resilient business models i.e., blue chip stocks, the ETF has not beaten the S&P 500 on price performance or total return. Investors favor and price up higher growth stocks independent of the dividend policy.
For further details see:
DGRO: Can Dividends Generate Alpha?