3 ETFs for Dividend Seekers

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar.com. Dividend-paying stocks are attractive to yield-seeking retirees. But a collection of high-quality dividend payers can make excellent core holdings for investors in accumulation mode, too. Joining me today to discuss some of Morningstar's favorite ETFs that target dividend-paying stocks is Adam McCullough. He is an analyst in our manager research group focusing on passive strategies.

Adam, thank you for joining us today.

Adam McCullough: Happy to be here today, Susan.

Dziubinski: Now, the first pick you wanted to focus on today is the only ETF that focuses on dividend-paying stocks that also happens to get a Gold fund analyst rating from us. It's also an ETF that focuses pretty much exclusively on dividend growth stocks, and it's Vanguard Dividend Appreciation. Why don't you tell us a little bit about that one?

McCullough: This is a fund looking for stocks that are willing and able to raise their dividend payments. So, it won't be the highest-yielding dividend-focused fund. It lands in Morningstar's large-blend category and its yield could be probably a little bit higher than Russell 1000, but it's looking for those stocks that are of high-quality and profitability that will be able to maintain their dividend payments.

What it does is, first, it applies a backward-looking 10-year screen for stocks that have raised their dividend payments for each of the last 10 years. That shows, one, that they are profitable enough to raise their dividend payments each year; and two, that their management is willing to raise the dividend payments in each of the last 10 years. This is good and bad in that it finds the more profitable names but precludes names that could probably sustain their dividend payments, like Apple, that haven't been paying dividends for the past 10 years.

Next, what it does is after it has this list of stocks that have raised their dividend payments, it weights them by their market cap. It skews toward the largest names of that set. All told, it holds about 180 stocks, and it's looking for those profitable names. It should hold up better during market downturns than the average fund in the category. In fact, during the financial crisis it only lost 46%, whereas the Russell 1000 lost about 55%. To boot, it's cheap. It only charges 8 basis points a year, which is also what supports its Morningstar Analyst Rating of Gold.

Dziubinski: The second ETF that we are going to talk about today is also another Vanguard dividend-focused ETF, but instead of focusing on dividend growers, this ETF focuses on higher dividend-paying stocks, is that right?

McCullough: That's right. This is Vanguard's answer to where is the yield. This fund averaged over the past five years has been about 3.4%. It's Vanguard High Dividend Yield ETF, easy enough. What this fund does is it looks for the top half of dividend payers based on their forward-looking yield and then it weights them by their market capitalization. This fund owns about 400 names, and it's less discerning than Vanguard Growth. It's not looking for quality metrics. It's saying, we're going to look for higher-than-average dividend payers but be so well diversified that we can withstand the impact of a stock that cuts its dividend payment or is at risk of cutting its dividend payment and has a price drop because of that. Whereas the Vanguard Growth Fund is a little bit more nimble, this is your tank that's going to be able to withstand dividend cutters but also offer that higher yield. It's a little bit riskier than the Vanguard Dividend growth fund, but it still earns a Morningstar Analyst Rating of Silver because the process is still solid in that it finds the larger dividend-yielding names and also, it's well-insulated against those that may cut their dividend, and it charges the same fee. It's only 8 basis points a year for this fund as well.

Dziubinski: The third ETF that we wanted to talk about today is also a Silver-rated fund. It also focuses on those higher-yielding dividend-paying stocks.

McCullough: This is the Schwab Dividend U.S. Equity Fund and it's a bit newer to the game. I think it came out in 2011. This is a bit of a hybrid between the Vanguard High Dividend Yield approach and the Vanguard Dividend Growth approach. What this fund does is it looks for, again at rank order stocks that are higher-than-average dividend payers. But then it scores them on some quality metrics.

This will look for stocks that have high ROEs, return on equities, so it can cover their dividend payments; better debt flow or cash flow to debt ratio, so it can keep those payments flowing to the end investors, but also look for dividend growth and dividend yield. It has kind of a 4-metric composite score that it assigns to all of these high-yielding companies, then it picks the top 100 of those and then weights those by market cap. It's going to own bigger stocks that pay higher dividend yields than the average stock but there's a little bit of a quality component to it. You have the extremes in Vanguard High Dividend Yield, Vanguard Dividend Appreciation.

The Schwab fund lands a little bit in the middle. It's still more toward the high yielding side. It lands in the large-value category. Yield here over the past five years, an average has been maybe 3.2%. Whereas Vanguard High Dividend Yield, 3.4%, and then Vanguard Dividend Appreciation's fund yield is probably 2.2% over the past five years. This fund is also cheap. It charges 7 basis points a year, and we think that its solid process to look for higher dividend payers but also apply some quality screens and then market-cap weight them will set it up to do well versus its category peers over the long haul and support its Morningstar Analyst Rating of Silver.

Dziubinski: It sounds like there's a lot of reasonably priced ETFs for dividend seekers to be considering.

Adam, thank you so much for your time today. We appreciate it.

McCullough: Absolutely. Thank you.

Dziubinski: For Morningstar.com, I'm Susan Dziubinski.