2023-07-24 12:06:23 ET
Summary
- Dividend growth investing is thriving in the current market environment, offering better risk-adjusted returns than high-yield investing, which has underperformed due to bleak fundamentals.
- The WisdomTree U.S. Quality Dividend Growth Fund ETF is a solid option for investors, with exposure to both high-growth and defensive sectors.
- The ETF's portfolio includes mega and large-cap tech stocks as well as growth stocks from defensive sectors like industrials, consumer defensive and healthcare.
Dividend investing is one of the most effective strategies for limiting risk while generating consistent long-term returns. However, in the current market environment, investors must exercise caution when making their selection because several dividend categories, including high-yield investing, have underperformed due to bleak fundamentals. Dividend growth is one of the few categories that is thriving in difficult times and can help investors achieve better risk-adjusted returns. In this regard, the WisdomTree U.S. Quality Dividend Growth Fund ETF ( DGRW ) appears to be a solid option, with portfolio exposure to both high-growth and defensive sectors.
Why Does Dividend Growth More Appealing Than High Yield?
Dividend-focused ETFs performed well during the 2022 bear market, but they underperformed significantly in 2023 due to a shift in market sentiment. The US stock market has entered bull territory, and market trends indicate that the rally will likely continue. Wall Street expects the S&P 500 to end the year around 4800 points, reflecting a high mid-single percentage growth from the current level. Furthermore, if the Fed achieves a soft landing and begins cutting interest rates in early 2024, the S&P 500 could end 2024 much higher than the 2023 forecast. Therefore, when markets are in such a state, growth stocks are more likely to outperform dividend stocks, making it challenging for dividend investors to achieve market-beating returns.
High-yield dividend investing, which is one of the most popular ways to earn monthly or quarterly cash income, is likely to suffer the most. This is because the majority of high-yielding stocks are small or mid-caps and belong to sectors like financial and real estate. These firms are at risk of underperforming in the current market conditions due to economic difficulties and the Fed's rate hike policy, which have stressed their business models and created a lot of pressure on their financial results. Invesco High Yield Equity Dividend Achievers ETF ( PEY ) is an excellent example of an underperforming high-yielding ETF. The ETF invests in the top 50 highest-yielding stocks in the NASDAQ US Dividend Achievers Index. Click here to find out more about Invesco High Yield Equity Dividend AchieversTM ETF and high-yield investing.
Dividend growth, on the other hand, has outperformed the other dividend themes. So far in 2023, the WisdomTree U.S. Quality Dividend Growth Index has slightly underperformed the broader market. However, its return of 14.22% compared to the S&P 500's 18.62% still looks appealing given the lower risk factor. Dividend growth stocks pay a lower dividend yield but have the potential to provide solid growth and capital appreciation. Furthermore, approximately 97% of dividend growth stocks in the index are large caps, which are better positioned to perform well in slowing economic conditions. The Index is comprised of 300 stocks with a combination of growth and quality factors.
How Does DGRW Achieve High Returns With Low Risk?
Rather than chasing high yields, quality dividend growth stocks or ETFs may be a better option. The WisdomTree US Quality Dividend Growth Fund ETF is a top dividend growth ETF that follows the performance of the WisdomTree US Quality Dividend Growth Index. In the last five years, the ETF has generated average annual dividend growth of 10% while shares have appreciated at a healthy rate, resulting in total returns of 71% compared to 61% for the broader market index. Even though the ETF has underperformed by only 4% so far in the 2023 bull market, the returns still seem attractive when taking risk management and lower returns from other categories into account. Furthermore, the returns appear more appealing given its expense ratio of 0.28%, which is significantly lower than PEY's 0.52%.
DGRW's sector exposure and portfolio management also place it in a good position to generate solid returns in both current and future market conditions. Its portfolio is heavily weighted toward large and mega-cap stocks in fast-growing industries like technology. Furthermore, growth stocks from defensive sectors such as healthcare, consumer defense, and industrials are heavily weighted in the portfolio. The struggling financial sector accounts for around 12% of portfolio weightage, but the majority of holdings are in large-cap banks that are well-positioned to deal with liquidity issues.
Among its largest stock holdings are high-quality tech companies such as Microsoft ( MSFT ), Apple ( AAPL ), Broadcom ( AVGO ), and Cisco Systems ( CSCO ). These companies are not only capable of generating high dividend growth, but they also offer solid price appreciation. Indeed, these firms are among the major share price drivers of the bull market. As a result, if the bull run continues, which seems likely, DGRW's portfolio will benefit from its stake in high-quality mega and large-cap tech stocks.
For example, Microsoft's stock has risen nearly 43% since the beginning of the year, owing to its growth potential and overall bullish market conditions. The company has aggressively invested billions of dollars in AI-related ventures and products to gain a dominant position in fast-growing technology. According to Morgan Stanley analyst Keith Weiss, Microsoft's leadership in AI may help generate robust revenue growth and push earnings growth to the high teens. In addition to the potential contribution of AI, the business has already been experiencing strong financial growth year over year. On a constant currency basis, the company reported a 10% increase in revenue and a 14% increase in net income for the March quarter.
Broadcom, a chipmaker, has also been aggressively capitalizing on the growing demand for artificial intelligence. AI has sparked a surge in orders for its chips used in data centers for networking. It also offers specialized chips to increase the speed of AI work. According to Hock Tan, Chief Executive Officer, generative AI could account for more than 25% of the company's semiconductor revenue in 2024. Nvidia ( NVDA ), a key contributor to ChatGPU's success, is also a key holding in DGRW's portfolio.
Aside from large-cap tech stocks, its holdings in large-cap consumer defensive companies help protect its portfolio during downturns. Procter & Gamble ( PG ), Coca-Cola ( KO ), The Home Depot ( HD ), and Philips Morris International ( PM ) are all large-cap consumer defensive companies with well-established businesses and the potential to generate long-term sustainable growth. Additionally, its portfolio contains healthcare brands like Merck ( MRK ) and Johnson & Johnson ( JNJ ), which also have the potential to offer long-term sustainable returns.
Its key stock holdings in the financial sector include Morgan Stanley ( MS ), Wells Fargo & Company ( WFC ), and American Express Company ( AXP ). Morgan Stanley and Wells Fargo both exceeded revenue and earnings estimates for the March quarter. MS has already increased its quarterly dividend by 9.7%, and WFC's robust outlook indicates that dividend growth is likely. Overall, DGRW's portfolio concentration in mega and large-cap growth stocks from various sectors appears to help generate solid returns in bullish trends while lowering risk in bearish trends.
Quant Rating
Quantitative analysis is one of the most effective methods for keeping emotions out of decisions. DGRW received a buy rating with a quant score of 4.20. All quantitative factors favored the ETF. For example, it received an A grade on the momentum factor. Momentum is a technical indicator that indicates the strength of stock price movement to the up or downside. As the price of DGRW is rising, an A score indicates that the momentum is strong and that the uptrend is likely to continue. The dividend factor also received a high grade, reflecting its strong dividend history and the potential for future growth. Moreover, the robust growth trend of tech stock holdings along with the steady growth potential of consumer defensive, healthcare, and banking stocks, indicate that the ETF is well-positioned to raise dividends. Furthermore, its low price volatility and short interest ratio help it earn an A grade on a risk factor. On the other hand, high-yielding ETFs like PEY received a poor quant score and hold rating.
In Conclusion
Chasing high yields can help investors earn high returns, but it can also become a trap at times. This is because a high yield does not help investors earn high returns unless it is accompanied by price growth. The challenging conditions for mid- and small-cap regional banks, insurance, and real estate firms may keep shares of high-yielding ETFs under pressure. Meanwhile, dividend growth ETFs such as DGRW are well positioned to generate both dividend growth and share price gains due to their portfolio exposure to large-cap growth stocks.
For further details see:
DGRW: Dividend Growth Likely To Beat High Yield