2023-09-01 13:47:33 ET
Summary
- DGRW lags behind its peers in terms of dividend growth.
- Future dividend performance relies on a few companies in the fund's portfolio.
- I believe DGRW is not the best fit for investors adopting a dividend growth strategy.
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Investment Thesis
WisdomTree U.S. Quality Dividend Growth Fund ETF (DGRW) is an ETF with a dividend growth tilt: but that tilt isn't giving its dividend growth strategy an advantage. The ETF has performed well, but as a fund focused on dividend growth, there are better dividend performing investment options with less holding concentration risk.
Fund Overview
DGRW has been around for just over 10 years and tracks the WisdomTree U.S. Quality Dividend Growth Index. With $9.61 billion in AUM and a modest 0.28% Expense Ratio, the fund has performed well in terms of total return at a 11.95% CAGR since inception vs. the SPDR S&P 500 ETF Trust's (SPY) 11.77% CAGR over the same time period. It has a dividend yield of 1.90%, a 5-year Dividend Growth CAGR of 8.84%, and pays dividends monthly. Overall, the fund has provided capital appreciation and larger yield than standard index funds. I expect this total return and dividend growth performance to continue as the fund contains high-quality dividend paying companies. However, I also believe the fund's dividend growth will continue underperforming relative to its peers in the future.
Strategy and Characteristics
DGRW focuses on measures of profitability to screen for companies using the following criteria
- According to the fund's website , "The Index is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share".
- Return on equity ((ROE)) which measures how much profit a company generates with the money shareholders have invested
- Return on assets (ROA) which measures the profits divided by the firm's total assets. Higher ROA indicates greater profits relative to the level of assets utilized to generate them
Methodology
Essentially, these three metrics measure the ability of a company to generate higher future earnings, which theoretically should lead to increased dividend payouts. Eligible companies are ranked using a weighted combination of the three factors. The fund's investment methodology is as detailed below.
- 50% weighted to the rank of medium-term estimated earnings growth
- 25% weighted to the rank of the historical 3-year average return on ROE
- 25% weighted to the rank of the historical 3-year average return on ROA
Companies that exhibit higher earnings potential are weighted higher, but that doesn't mean they'll actually payout more dividends. The top 300 holdings of this combined ranking will be selected for inclusion in DGRW.
Holdings Breakdown
DGRW's holdings breakdown is as follows:
There is a slightly heavier weighting in the Technology sector relative to the S&P500 at 29.14% vs. 27.75%, but more specifically it's heavily weighted in Microsoft (MSFT) and Apple (AAPL) at 8.33% and 5.67% respectively for a total of 14% of all AUM. These two companies also make up 50% of the fund's Technology sector weighting. Competing Dividend Growth ETFs have quite a range of holdings, amounting as high as 432 in iShares Core Dividend Growth ETF (DGRO) to only 104 in Schwab U.S. Dividend Equity ETF (SCHD) with significantly different sector and holdings weighting.
Performance vs. Peers
There are several popular ETFs competing in the realm of dividend growth. In order of increasing AUM: DGRW $9.61B, DGRO $23.84B, SCHD $48.70B, and VIG $68.67B. Bad news, DGRW is the worst performer in terms of pretty much all things dividends such as
- Dividend Growth CAGR
- Consecutive Years of Dividend Growth
- Dividend Yield ((TTM))
DGRW's 5-Year Dividend Growth CAGR has performed the worst of the four peers at 8.84% compared to next lowest at 9.89% for Vanguard Dividend Appreciation Index Fund ETF Shares ((VIG)) and the highest being SCHD at 13.92%. It has also not shown a significant amount of consecutive years of dividend growth, at only 2 years, whereas all its peers have 4-6x the consistency. Its yield is also markedly the lowest, about the same as VIG at 1.86%. Additionally, DGRW has the highest expense ratio of 0.28% while all its peers have expense ratios less than 0.1%.
Counter to this, DGRW has actually performed the best of the four funds in terms of total risk-adjusted returns and CAGR, including the S&P500 benchmark SPY. Since its inception in Jan 2015 or about 8.5 years ago, DGRW has returned 11.95%, the next highest dividend growth ETF being SCHD at 11.19%. It even outperformed the S&P500 at 11.77% or by about 0.18%. In terms of risk-adjusted returns, DGRW is also better when compared to its peers with a Sharpe Ratio of 0.76, VIG being the next highest at 0.72, showing DGRW has exhibited less volatility than its peers since its inception. Overall, DGRW is great for those seeking risk-adjusted total return, but not so great for those seeking competitive dividend growth.
From the data thus far, DGRW is a difficult purchase in my opinion from a broad perspective, since it has not considerably outperformed the S&P 500 and is underperforming in the dividend growth strategy it is intended for. As of slightly more recent data from 8/30/2023, DGRW's CAGR only outperforms SPY by 0.19%. Even compared to other funds such as Vanguard S&P 500 ETF (VOO), which shows almost the same CAGR performance as SPY. It does perform a bit better than Vanguard Total Stock Market Index Fund ETF Shares(VTI), but then again so does SPY and VOO, that's a whole other debate.
The Elephant in the Room
There is a heavy speculation weighing into this ETFs methodology that these two companies, Microsoft and Apple, will grow their dividends the most and at least one of them isn't doing it fast enough. Despite Microsoft's average yield dropping steadily to under 1% over the last 5 years it does have consistent and respectable 5 year dividend growth CAGR of 10.02%, I can live with that, this is dividend growth after all.
Apple on the other hand, has shown a similar decline in average yield but has a 5-year dividend growth CAGR of only 6.70% with a consistently declining dividend growth rate, steadily dropping from almost 9% to 5.20%
The weighted average of both Microsoft and Apple's dividend growth position in DGRW is 8.67%. Recall, these two companies represent about 14% of the fund. Even if the rest of DGRW, 86% of its holdings, performed at SCHDs 5 year dividend growth CAGR of 13.92%, the fund's 5-year dividend growth CAGR would still underperform at 13.19%. I even applied this to Microsoft just to see the full effect from Apple, and the fund would still underperform at 13.51%. It's clear that DGRW will continue lagging behind in terms of dividend growth, unless Apple aggressively raises its dividend in the coming years or gets replaced by another company in the weighting, which will also take many years for a change like that to surface.
Investment View Risk
In the same way these few companies constrain the dividend growth of the fund, they could contribute to its growth just as well. If Microsoft and especially Apple were to aggressively grow their dividend payouts, this fund could become more attractive for a dividend growth investor. These companies have immense cash on hand, Apple with about $51 billion and Microsoft with about $104 billion. They're also efficient in generating profits and, therefore, the potential to grow their dividend payouts. The key would be getting the cash on hand and profits distributed as aggressively increasing dividends to shareholders. Additionally, because the ETF is heavily weighted toward Apple and Microsoft, which are well established companies, it could provide more safety for investors than one that relies on the high yields of smaller, riskier stocks. Aside from these two companies, DGRW is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year. So, for that matter, this fund allows for other companies in the same position to grow their share in the fund as they are projected to and actually payout more dividends YoY.
Final Thoughts
DGRW is a high quality ETF, but if you're looking to it for dividend growth, look to its peers. Since it is so concentrated in two companies, the strategy ultimately has me concerned for it's future dividend growth. I really like the concept of including these technology companies that are legitimate dividend growth companies, I don't want to miss out, but the dividend growth as an ETF just isn't there. I think if an investor is adamant about having companies like Microsoft and Apple then a better hedge is DGRO, since it is weighted less at about 3% each and SCHD does not hold either of these companies.
Apple's inconsistent dividend growth has me wondering what their next move will be, and I can't rely on it being a higher dividend. In my opinion, relying on one stock in an ETF to drive return metrics is not ideal. Even if Apple's dividend growth accelerated, we would still have the same risk of relying on one very successful company contributing too much to and ETF's dividend performance. For that, DGRW is not a buy for my portfolio.
For further details see:
DGRW: Dividend Growth I Wouldn't Buy Into