As the economy falls further into bear market territory, it is clear that dividend investing strategies have held up better than most other investing strategies this year. Today I read an article from a Morningstar writer about which dividend investing strategies are outperforming year to date 2022. This article looked at how much that performance has varied depending on specific dividend investing approaches.
Generally speaking, there are usually two schools of thought when it comes to dividend investing: dividend yield investing vs. dividend growth investing. Dividend yield is calculated as the latest dividend payment annualized divided by price. Dividend growth is defined as the rate of change of dividends paid by a company over time, generally the most recent 3 or 5 year period. Clearly, a high dividend investor is more focused on the size of the dividends they receive while a dividend growth investor cares more about the historical and potential growth of the dividend. Both styles generally have the same goal, which is create an income stream.
However, an investor’s time horizon can play a significant role in determining which strategy they focus on. Older folks may want to put their money in high yielding yet consistent payers like Realty Income ($O) or Enterprise Products Partners ($EPD). This is because reliable income now is more important to them than growing long term wealth. For younger investors, it may make more sense to focus on a dividend growth strategy by investing in companies that have low payout ratios and potential to create a long track record of increasing dividends like Lowe’s ($LOW) or Visa ($V).
With dividend strategies faring better than most other for 2022, the article looked at which one is doing the best. The article concluded that strategies that invest in high yield companies with healthy financials outperformed the most. After reading that, I decided to evaluate that conclusion for myself by back-testing a handful of dividend paying ETFs which follow various strategies. Below are the ETFs that I was able to back-test through using Sharesight:
- ProShares Dividend Aristocrats ETF ($NOBL) which contains the numerous stocks of varying yields and growth potential that are on the dividend aristocrat list
- Vanguard High Dividend Yield ETF ($VYM) which contains the highest yielding stocks after being filtered by market cap adjustments
- Vanguard Dividend Appreciation ETF ($VIG) which contains stocks with at least a 10-year history of growing dividends after passing market cap and trading volume criteria
- Schwab US Dividend Equity ETF ($SCHD) which contains stocks that meet the criteria of both yield and fundamental aspects
- Global X S&P 500 Covered Call ETF ($XYLD) this is not a dividend ETF perse, however lots of dividend investors use covered call funds to use their high yields for income purposes
As you can see in the graph below, the S&P has fallen by 20.55% year to date. The best performer of the dividend strategies was the dividend yield strategy down by only 9.46% year to date, followed by the dividend fundamental strategy down by 10.74% year to date. Surprisingly, the covered call high yield ETF was a very close third down by only 10.77% year to date!
High yield investors (assuming sound quality of stocks) have stayed strong in this market, in part by the strong finances of their holdings but also sizable exposure to the energy sector. A high yield dividend strategy almost inherently has extra exposure to energy and little exposure to tech. High yield strategies with a quality focus on seeking profitable firms in a position to consistently pay their dividends over many years and dumping the ones that can’t, are in a great position to keep the dividends flowing which is provides important financial stability even if a recession hits.
Though energy is starting to waiver, the sector’s performance this year is primarily the determinate of the success of these dividend funds. Energy tends to be much more prominent in dividend and value portfolios. $VYM, our high yield ETF, has the second highest yield at 2.79% and has greatest exposure to the energy sector at over 10%. That is more than double the S&P’s energy exposure at 4.68%
Dividend growth strategies haven’t done as well this year, mainly because of their exposure to tech. For example, our high yield ETF $VYM has 8.37% exposure to tech whereas its growth counterpart $VIG has more than double that at 16.78%. Prior to this year, most dividend strategies in general had not performed well when compared to the market. Even with a focus on which quality, dividend stocks tend to have a hard to keeping up when the market is focused on growth. However, now that the tide of the economy has turned, dividend investing, whether that is with an emphasis on yield or on dividend growth, is shining bright as the safeguard against this volatile market.