Welcome to the second episode of my dividend analysis series where I’m taking a deep dive into ETFs like DGRO.
If you want some insight into this series then check out the first post here where I reviewed SCHD. In essence, in this series, I’m taking a close look at portfolio construction, performance and dividend growth of these ETFs with the goal of finding the best ones for me to invest in at the end of the day.
Today, I’m looking at the iShares Core Dividend Growth ETF or DGRO.
According to Blackrock, this ETF seeks to track the investment results of an index composed of U.S. equities with a history of consistently growing dividends.
You can see some high level details below and as always can get more up to date information in this google spreadsheet that will list all of the ETFs reviewed in this series at most up to date prices, P/E ratios and yields.
A passive strategy leads to a low expense ratio which is always good for investors and while it’s not the largest ETF in this space, it’s quite sizable which means there should be no issues with volume or bid/ask spreads.
The ETF started well after the 2008 recession so the data won’t be very robust but will at least capture the recent downturn as well as the 2020 pandemic reaction. The goal here would be continued growth during that timeframe and less volatility than a typical index.
Based on the latest 12 months of dividends, the yield an investor gets today is a bit lower than the 5 year average which may speak a bit to overvaluation but we’ll dive into that a bit later into more detail.
Before we do that though, let’s look into how this ETF comes together and whether the underlying index construction makes sense.
DGRO follows a passive strategy tying itself to an index. In this case, it is the Morningstar U.S. Dividend Growth Index. This index has an inception date of April 07, 2014 so the data isn’t any more robust than the ETF.
In order to be included in this index, stocks must be part of the Morningstar U.S. Market Index, a broad index that represents 97% of U.S. equity market capitalization and is made up of about 1540 constituents.
From that starting point, a stock must meet the following basic criteria to be included in the final index.
- Dividends must be qualified income which automatically excludes things like REITs. This is a common theme in some of these dividend ETFs and is done to improve tax efficiency.
- Dividend yield must not be in the top 10% of the universe which excludes the stocks with the highest yield.
- Payout ratio must be less than 75% and the stock must have a positive consensus earnings forecast. Payout ratio here is forward looking and calculated by the forward 12 month dividend payout divided by the forward 12 month consensus earnings per share forecast.
- The stock must have five years of uninterrupted annual dividend growth and must be currently paying a dividend.
- In the case of a spin-off, the spin-off remains in the index but will require continued dividend growth in the next year to remain in the index.
- A stock that fails to raise dividends but does not decrease their dividend AND executes a share repurchases in the 12 months preceding reconstitution of the index resulting in a net decrease in shares will remain in the index.
Those criteria whittle down those initial 1540 constituents to about 414 final companies that are included in DGRO.
The securities are dividend-dollar weighted and individual securities are capped at 3% at time of reconstitution. The weighting model emphasizes total dividend payouts which leads to an emphasis on larger companies. The total dividend payouts for each stock are calculated by the dividend per share for each stock multiplied by the number of shares outstanding. This type of weighting tends to anchor the company to more mega cap companies which can add some stability and help with things such as turnover and capacity to invest as AUM grows.
The 3% max and the # of companies means that DGRO won’t be as top heavy as something like SCHD which only has 100 stocks.
Overall, the criteria mostly make sense but a few stand out as a bit odd to me.
First, the index avoids the top 10% yielding companies which serves to lower overall yield. I understand why they do it since companies with a very high yield CAN be yield traps that are more likely to cut dividends and/or grow dividends at a slow pace.
However, that’s not always the case and it seems like the 75% payout ratio screen might limit the inclusion of such companies.
Second, the index will not remove stocks that fail to raise a dividend as long as they execute share repurchases and thus lower share count. This is likely there to lower turnover and keep costs and tax impact low.
However, it seems like it goes against the goal of this ETF as the stocks are not growing dividends. That may impact dividend growth of an ETF like since stocks can just buy back shares and not raise dividends and still stay in the ETF. I suppose their take is that stock buy backs are still a form of investor return but not in the way most buyers of this ETF would prefer.
I would think many who own DGRO don’t know this qualification is in there because it’s an odd thing to include in a dividend focused ETF.
The index is reconstituted annually and rebalanced quarterly. Because the reconstitution of the parent index is done semi-annually, stocks that get removed from the U.S. Market Index at the time of that semi-annual reconstitution would also be removed from this index then. Given the breadth of that index, I would think this would be a rare happening.
Overall, this leads to a portfolio that is full of familiar names.
Information Technology and Financials are the leading sector each with about a 20% weighing.
The top 10 names include Apple, Microsoft, Johnson & Johnson, Proctor & Gamble, JPMorgan Chase, Home Depot, Pfizer, Coca-Cola, Merck, and Cisco Systems.
These top 10 names make up 24.4% of the index.
Unlike SCHD, DGRO does include some of the larger cap technology names like Apple or Microsoft which may not have a high yield but do have a history of paying and growing dividends. However, there’s still a good amount of overlap between the two as 5 out of the 10 names exist in the top 10 list of both ETFs.
Overall, DGRO’s construction generally makes sense although two of the rules seem a bit odd for a dividend ETF. It seems like both rules might have a negative impact on yield and on growth as well which is the focus of this ETF but we’ll see if that’s the case now.
Dividend History and Growth
Dividend growth is in the name of this ETF so I would expect solid and consistent dividend growth at the sacrifice of yield. We already know that yield is just north of 2% so this isn’t a huge income producer but hopefully that’s offset by fantastic growth that would fuel a better yield in the future.
Let’s go straight to the charts and see if that’s the case. The first full year of payouts for this ETF was 2015 which is where the data starts.
The graph looks good in that it has a consistently upward trajectory but with a name like DGRO, I was hoping for more of that GRO. Holders here have been rewarded with a growing dividend and one that grew through turbulent times like 2020. However, is the growth rate enough for an ETF focused on growth?
While there have been some solid double digit growth rates including one in 2020, there have also been some slowdowns including one in 2021.
The overall dividend growth rate for DGRO since inception is 9.09% which isn’t bad at all but it does lag SCHD’s 11.9% in that same time frame.
For a dividend ETF more focused on growth than yield, this failure to beat that rate is a bit of a surprise. It’s still better than the 5.6% the S&P 500 produced in that same time frame but that’s not the best comparable.
Today’s yield of 2.13% is lower than SCHD as well so you’re getting a lower yield and lower growth? That’s certainly not the best result.
I do wonder if the strategy of excluding the highest 10% of yielders AND allowing companies that fail to raise their dividend but buy back shares to stay in the index has an impact on both results.
After all, the 4.2% growth in 2021 after a year where many companies had some financial distress makes you wonder if that’s what happened to some of those names(no dividend raise but bought back shares). An ETF like SCHD also saw a slowdown in growth in 2021 compared to prior years but still was able to growth payouts by 10.9%.
If you’re a company that’s not growing dividends then why are you in a dividend growth ETF? Just seems odd to me.
There’s another concern in that the payouts in the first half of 2022 are actually down 5% from the first half of 2021. That doesn’t mean the year will end in a reduction as underlying holdings may change the payouts in various quarters so DGRO may very well end that year in the positives but it’s not a great sign.
Still, there are some bright spots. The ETF continued growing dividends through 2020, something the S&P 500 failed to do which does show that the strategy is working in that regard. Plus, the index has more flexibility that many when it comes to yield which allows high performers like Apple and Microsoft to sneak in which may be beneficial when it comes to performance. That second part has to play out in the results so let’s take a look at that now.
Dividends are important but if total returns are lagging then that might be even more of a concern.
Now that I have one ETF analysis under my belt, I can start comparing dividend ETFs to dividend ETFs and seeing those results.
The data will still be constrained by the creation date of the ETF and DGRO will be that constraint here as it’s the newest of the two. In this case we’ll be looking at January 2015 to July 2022.
To keep it simple, the data will reflect $10,000 invested at the beginning of the investment period with dividends re-invested.
Overall, the results are pretty good. DGRO is right in line with the competitors and tracks well against both the S&P 500 and SCHD.
It is a bit of a surprise that DGRO lags something like SCHD just a bit as one would have thought a bigger focus on some growth holdings would have given it an edge.
However, I think while those were certainly a positive in 2020 and 2021, the recent downturn has more heavily impacted some of those names. Still, even excluding YTD performance, DGRO was a bit of a laggard.
Just like SCHD, DGRO does beat out the S&P 500 with its worst year although the max drawdown between Jan and March 2020 was higher than the S&P 500s between January and June of this year. The good thing is that DGRO had a swift recovery by November and ended 2020 in the positive.
You can see the yearly performance of the three ETFs below.
It seems like from a performance perspective, all three are pretty solid. DGRO and its dividend ETF brethren do have less yearly volatility than something like the S&P 500 while keeping similar overall performance.
With DGRO, you also get better dividend growth than the S&P as shown below.
In 2015, DGRO’s payouts were 17% higher than the S&P 500 and by 2021, they were over 44% higher showing that growth advantage.
However, as we discussed above, the growth did lag SCHD and the 18% gap that existed between them in 2015 turned into a 46% gap by 2021.
Still, based on the returns here, I think investors in DGRO can be relatively happy with what they’ve gotten in the past few years. It’s no slam dunk but it’s certainly not a huge disappointment.
DGRO Overview, Valuation and Scorecard
DGRO is a relatively young ETF but one that has proven itself with solid performance.
The low expense ratio keeps it investor friendly and the focus on dividend growers appeals to those looking for income well in the future as the focus here is not on yield.
Still, the sub 10% dividend growth rate is a bit of a surprise considering the name and I wonder if part of that is due to the unorthodox nature of the index it follows. I don’t love the fact that you can keep your dividend steady and just buy back shares and stay in the index. That seems like it would stall dividend growth but perhaps there’s some data that shows that it helps performance.
Speaking of performance, it has been pretty good here even if it lags SCHD and the S&P 500 a tiny bit. Generally when the difference in CAGR is so small, I’d gauge the performance as about equal as one good month can swing the results one way or the other.
The market did take a bit of a dip recently. As of 8/30/22, from a valuation perspective, the P/E of 16.28 compares favorably against a 20.1x multiple for the S&P 500 but is a bit higher than the 14.68 P/E you see from SCHD.
DGRO sits about 12.85% off its 52 week high which is favorable against something like the S&P which is down nearly 18%. However, DGRO’s current yield of 2.13% isn’t particularly attractive against it’s 5 year average of 2.21%. Part of that may be due to slowing dividend growth which when paired with rising prices may impair yield.
You can also see how that compares against the various historical yields in the dataset below.
While a 2.13% yield is by no means bad as this ETF rarely trades well above that, it’s not particularly enticing by historical yield standards. The slowing growth in the recent year and the actual reduction in the first half of 2022 is a bit of a concern. If growth doesn’t tick up then that may drive yield down unless prices continue falling. Investors looking for yield won’t find it here and a slowing growth rate means your yield on cost won’t be rising as quickly as it could with other funds with a better growth rate.
Overall, DGRO is by no means a bad ETF but it is a tad disappointing to see a dividend growth focused ETF lack that oomph on the growth side. You get a lower yield than something like SCHD and dividend growth that lags behind as well.
Overall performance is still solid but it’s not a clear winner on that front either with both SCHD and the S&P 500 beating it slightly.
Given that, I can’t help but give it slightly lower scores across most categories then the first reviewed ETF in this very unscientific scorecard.
While the cost structure and performance are about equal, everything else is just a bit worse. I’d expect better growth from something with a name like DGRO because when you’re giving up yield, you expect to eventually catch up with growth and so far that hasn’t been true. The growth score would have been higher if not for the recent downturn in growth as well which worries me a bit.
The valuation isn’t overly enticing right now but part of that is driven by that lackluster growth in recent years. I do own DGRO but I am not currently buying it as it hasn’t really done what I expected it to do on the growth front. I’d like the valuation to be a bit more enticing before I get back into buying as my last purchases of DGRO were way back when in 2020 when yields were north of 3%. If it ever gets close to that level again, I’d probably jump back in and only if we see a return to growth on the dividend side as well.
Thanks for reading and as always let me know your thoughts and if you’d want me to review some specific dividend ETFs in this format. As this is a new series, I’m definitely looking for more feedback.
Disclosure : I am long SCHD and maybe be long other stocks discussed in this article. This is not investment advice and I am not a financial advisor. Please talk to a professional before investing as any investments come with risk of loss, sometimes permanent. This blog is for entertainment purposes only. Returns represent past performance and are not a guarantee of future performance.