Companies' management teams tend to take their commitment to return cash to shareholders pretty seriously. Dividend cuts or eliminations are often severely punished by the market because they indicate financial distress ( General Electric (GE) is a recent case in point). Therefore, companies that have a history of paying (or increasing) their dividends tend to be the types of businesses that investors like to own: Many are competitively well-positioned, steady cash-generating businesses.
To find companies with a history of dividend growth--and the ability to sustain it--the Morningstar US Dividend Growth Index uses several screens. First, we cull the U.S. equity market for securities that pay qualified dividends. (This excludes real estate investment trusts.) Index constituents must exhibit a five-year history of increasing their dividend payments. To gauge the sustainability of dividend growth, eligible constituents must display positive consensus earnings forecasts from the analyst community. As a safeguard against dividend cuts and financial distress, stocks with indicated dividend yield in the top 10% of the universe are excluded. Finally, existing constituents are allowed to remain if they have recently bought back shares and have not decreased their dividend payment.
Karen Wallace, CFP® does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.