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Choosing the Right Dividend ETF

Well, it happened — again. The 10-year Treasury fell all the way to 2.3% last week on a string of bad geopolitical news and mixed economic data. The last time yields were this low was June of last year, in the early stages of the “Taper Tantrum.”

Could yields continue to go lower? Sure, they could. But it doesn’t matter. If you are an income investor with more than a five year horizon, you should be looking outside of the bond market for your income needs given the pitifully low yields on offer. And one area that still looks attractive at today’s prices is the world of dividend ETFs.

Company dividends — unlike bond interest — generally rise over time, giving dividend stocks far better long-term inflation protection than bonds.

Not all dividend stocks are the same; some are slow-growth dinosaurs that are little better than bonds with respect to their sensitivity to rising interest rates. Others are high-growth dynamos that share their bounty with their investors by continually raising their dividend. And in the same way, not all dividend ETFs are the same. Some are concentrated in slower-growth companies and sectors, while others are a who’s who list of quality growth stocks.

I don’t like choosing between growth and income; I want both. And today, I’m going to share some of my favorite dividend ETFs that I expect to deliver the two.

High Dividend Yield

Any discussion of dividend ETFs should start with the granddaddy of them all, the iShares Select Dividend ETF (DVY). 

 DVY’s underlying index takes the universe of dividend-paying stocks with a positive dividend-per-share growth rate, a payout ratio of 60 percent or less, and at least a five year track record of dividend payment and then selects the 100 highest-yielding stocks.  The result is an ETF loaded with high-yielding, reliable dividend payers.

Not surprisingly, DVY is heavily weighted in utilities and defensive consumer staples, currently 34 percent and 16 percent of the portfolio, respectively.  The current dividend yield is 3.1%—significantly higher than what the 10-year Treasury pays.

As it is currently constructed, DVY is not likely to outperform the S&P 500 in a normal, rising market.  It should, however, hold up far better during a market rout—though this was not the case during the last bear market. DVY took a beating in 2008 because it had a high allocation to the financial sector at the time.

Dividend Growth

DVY is fine for current income.  But if it is growth you seek, try shares of the Vanguard Dividend Appreciation ETF (VIG)—a long-time favorite of mine.  At 2.0 percent, VIG’s yield is not significantly higher than the S&P 500.  But you don’t buy VIG for its dividend today; you buy it for its dividend tomorrow

VIG is based on the Dividend Achievers Select Index, which requires its constituents to have at least 10 consecutive years of rising dividends.  The rationale is easy enough to understand.  There is no signal more powerful than that of a rising dividend.  Company boards hate parting with their cash; it’s a natural human instinct to stockpile it—just in case.  A willingness to part with the cash is a signal that management sees a lot more of it coming.

Paying a dividend requires discipline, as it means less cash to waste on value-destroying empire building.  And a rising dividend also shows that management knows its place.  They work for you, the shareholder, and increasing your dividend every year is a way of showing that they have their priorities straight.

By definition, any stock currently in the portfolio continued to raise its dividend even during the crisis years of 2008 and 2009.  These are companies that can survive Armageddon because, frankly, they already have.

There are drawbacks to VIG’s 10-year screening criteria.  A more recent dividend-raising powerhouse like Apple (AAPL) lacks the history to be included in the Vanguard ETF. Also, as with any investment strategy that depends on historical data, there is no guarantee that a ten-year streak of raising dividends in the past will mean another good ten years of increased payouts going forward.

Still, if you’re looking for a portfolio high-quality stocks with a long history of rewarding shareholders, then VIG’s dividend growth methodology is a fine plan place to start.

VIG is not the only ETF to focus on dividend growth, of course.  PowerShares runs two competing products. The PowerShares Dividend Achievers ETF (PFM) is based on the same underlying index as VIG, though its fees are higher—0.55% vs. 0.10%.  It’s hard to justify losing almost half a percent a year in additional fees for what is substantially the same investment product.

The PowerShares High Yield Equity Dividend Achievers ETF (PEY) offers a smaller, higher-yielding slice of the dividend achievers universe, taking only the 50 highest-yielding stocks from the dividend achievers screen.  Though also more expensive than VIG with an expense ratio of 0.55%, it pays a higher yield at 3.4%.

And finally, Standard & Poor’s has its own competing dividend growth strategy called the Dividend Aristocrats, which goes even further than the Dividend Achievers. The S&P 500 Dividend Aristocrats Index measures the performance of the companies within the S&P 500 that have increased their dividends every year for the last twenty five or more consecutive years.

The SPDR S&P Dividend ETF (SDY) is an ETF that builds a portfolio out of the 50 highest-yielding Aristocrats.

So, if I love the 10-year Achiever screen, I should really love the 25-year Aristocrat screen, right?

Well, in principal, yes.  Though in practice, I find it to be a little too restricting.  Limiting your pool of stocks to companies that have raised their dividend for 25 consecutive years leaves you with a portfolio of older, slower-growing stocks.

Don’t get me wrong; there are some real gems in SDY’s portfolio, including long-time favorites of mine National Retail Properties (NNN), Target Corp (TGT) and Procter & Gamble (PG).  But overall, in SDY, you are left with a defensive portfolio that I would expect to lag during a normal bull market.

Combing Dividend Investing With Guru Following Strategies

One brand new dividend ETF is the AdvisorShares Athena High Dividend ETF (DIVI), which I wrote about earlier this month when it launched.

DIVI is managed by Thomas Howard, a former academic turned money manager superstar and the author of Behavioral Portfolio Management. It is also very different from all other dividend ETFs I follow.  Virtually uniquely among dividend ETFs, DIVI includes equity REITs, mortgage REITs, master limited partnerships (MLPs), closed-end funds and business development companies (BDCs) in its investment universe, giving it a vastly different portfolio composition than its competitors.

Also uniquely among dividend ETF, DIVI employs a guru-following strategy that makes it similar in principle to Global X Top Guru Holdings Index ETF (GURU) and the AlphaClone Alternative Alpha ETF (ALFA), but with a more active management style. DIVI uses Howard’s behavioral research to identify the “high conviction” picks of active mutual fund managers, then selects high-dividend payers from the screen. DIVI then diversifies across sector, strategy and country to reduce risk.

DIVI is a little on the expensive side for a dividend ETF with a net expense ratio of 0.99%.  But given that DIVI is essentially an actively-managed mutual fund in an ETF wrapper, the expenses are not disproportionate.

Of course, no discussion of a dividend ETF is complete without a mention of the dividend yield.  DIVI has been trading for less than a month and thus has no historical dividend yield.  Based on the average yield of its top holdings, minus manager fees and expenses, I believe that it will generate in excess of 5% per year in dividends and perhaps more.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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How to Invest in the American Energy Boom

The fracking boom is old news, but there are new ways to play it.  Jeff Reeves and I discuss:

The new American energy boom is one of the most exciting macro developments of our lifetimes. Non-conventional drilling and extraction methods — such as hydraulic fracturing, or “fracking” — have unlocked a century’s worth of oil and natural gas that was previously unrecoverable, setting off an investment boom unlike anything we’ve seen in the United States for over 100 years.

We’re talking about the reversal of a 30-year trend that will upend global trade flows and rewrite the geopolitical map. And shrewd investors can take advantage now, before the rest of the public catches wind of this megatrend.

Based on the most recent government estimates, the U.S. now has nearly two-and-a-half quadrillion cubic feet of natural gas that is recoverable. That number is almost so big as to sound nonsensical, but as new deposits are discovered, I expect this number to tick even higher in the coming years.

You need look no further than Ukraine to see how important it is that the United States pursue not only energy independence, but also energy export capability. Russia was able to seize Crimea and launch a proxy war in eastern Ukraine without any significant response from the West. This isn’t the 1980s, and it’s not that Europe and America fear Russian nuclear missiles: They fear that Russia will turn off the gas tap and create the biggest energy crisis since the 1970s!

As we saw in that decade of stagflation, high imported energy prices can bring the U.S. and European economies to their knees.

Another strategic concern is U.S. trade policy and the imbalances created by America’s persistently high current account deficits. The U.S. consistently imports more than it exports (even during recessions!), which means that we flood the world capital markets with dollars. Those dollars, for lack of anywhere else to go, flow back in the U.S. Treasury market.

All else equal, chronic trade deficits should cause the dollar to lose value over time and should lead to domestic inflation. But worse — and returning to the theme of geopolitical risk — they have the effect of making the U.S. a debtor nation to regimes that aren’t always the friendliest. Are you comfortable with China being America’s loan shark? I know I’m not.

Abundant cheap energy means at least a partial solution to the imbalances that have plagued the United States for the past two decades. Cheaper energy, lower trade deficits and less need to get entangled in the political affairs of oil-exporting nations are all major positives. And at a time when ordinary consumers face tight budgets, reducing a nondiscretionary expense like energy means more money available for discretionary spending.

Big Opportunity in American Energy Stocks

But profiting from this theme can be tricky. Energy prices are volatile, and even if you have the long-term direction right, you can get killed by short-term price fluctuations. Speculating in the oil and gas market is a one-way street to an early heart attack … or at the very least an ulcer!

My favorite low-risk way to play this long-term macro theme is by buying the pipeline infrastructure that transports the oil and gas. The most popular way to do this is via master limited partnerships (“MLPs”), which are tax-efficient vehicles that tend to throw off very high dividends. They’ve been an excellent asset class over the past decade, recent volatility notwithstanding.

But rather than recommend MLPs, I prefer what I like to call “MLPs on steroids” — the general partners that control the MLPs and take a disproportionate amount of the profits.

General partners are compensated for their efforts via what is known as incentive distribution rights (“IDRs”). Under a typical IDR arrangement, the GP is incentivized to grow the cash distribution to limited partners by taking an ever-greater share of the increase; the higher the GP boosts the cash distribution, the more of it they get to keep for themselves, though it usually caps out at around 50%.

If you are a long-term investor looking for growth and income, the GPs will generally be the way to go, as their faster dividend growth rates make them more attractive as growth investments. Also, unlike MLPs, GPs can be safely held in an IRA or Roth IRA account without generating complicated tax headaches.

There are several good GPs to choose from. One I particularly like is Williams Companies (WMB). Williams is undergoing a restructuring that will see it emerge as a “pure play” general partner with leveraged exposure to one of the biggest and highest-quality underlying MLPs —Williams Partners (WPZ). Though Williams has already enjoyed a nice rally in 2014, I expect it rise by another 50%-100% over the next 12-18 months.

This post first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Realty Income: Another BORING and Solid Quarter for the Monthly Dividend Company

It was another solid quarter for Realty Income (O)—one of my very favorite long-term dividend machines.

Revenues jumped 22.6% on the back of new property investments and a 1.4% increase in same-store rents.  During the quarter, Realty Income raised $528 million in a secondary share offering and ploughed $405 million of it into new properties and development projects while managing to modestly increase its occupancy rate from 98.2% to 98.3%.  The new properties have a weighted average lease maturity of 10.6 years and a lease yield of 7.3%, meaning that these should be nice income generators for a long time to come.

Funds from operations (FFO)—the most common metric of profitability for REITs—increased 21.1% and 6.7% per share.  For the uninitiated,  FFO is a measure of net income that adds back non-cash charges like depreciation and backs out gains on the sale of properties.  The idea is to give a more accurate measure of real operating performance and of the cold, hard cash being generated for the payment of dividends.

And speaking of dividends, Realty Income increased its monthly dividend in June for the 76th time in its history and for the 67th consecutive quarter (see “5 Monthly Dividend Stocks”).  Since going public in 1994, Realty Income has churned out 527 dividend checks, making it one of the most dependable income payers to ever be traded publically.

This gets to the crux of why I love Realty Income and why I consider it far better than a bond for your retirement income needs.  Right now, Realty Income pays an annualized dividend of $2.19.  Ten years ago, it paid an annualized dividend of $1.22.  So, if you had retired in 2004, using your Realty Income dividends to pay your bills, you would have seen your income rise by fully 80%, far outpacing inflation.  And this says nothing at all about capital gains, which were substantial.

Had you instead purchased a 10-year bond, your income would not have changed; the coupon payment you received in 2014 would be the same as the first one you received in 2004.  And looking at current bond yields, your income would actually fall significantly if you were to reinvest the proceeds in today’s market.

Rather than think of Realty Income as a stock, I prefer to think of it as a perpetual bond with a rising, inflation-beating payout.  Yes, it is “riskier” than your average corporate bond in that its stock price is more prone to fluctuation than that of a bond.  As a case in point, O stock lost a third of its value during last year’s “taper tantrum.”

But if you’re buying it as an income generator, price fluctuations really don’t matter—so long as the business remains strong and the dividend remains intact.  And on that count, Realty Income passes the test with flying colors. Its portfolio is full of high-quality, recession-resistant properties; its “typical” property is a pharmacy run by Walgreens (WAG) or CVS Caremark (CVS).

Realty Income continued to pay and raise its dividend throughout the crisis years—and in my book, that qualifies O stock as a viable income substitute for bonds.

The question simply becomes one of price.  Realty Income currently yields 4.9%.  In a world in which the 10-year Treasury yields 2.5%, that’s attractive.  I would consider Realty Income a buy at a yield of 4.5% or higher.

If you are still years away from retirement, consider instructing your broker to automatically reinvest the monthly dividends.  I personally own shares, and that is exactly what I do.  I hope to leave these shares to my children decades from now, and if they are smart they will hold on to them and pass them on to their own children.

This post first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Blast from the Past: Walmart Dividend Letter from 1985

I was digging through an old file cabinet that had belonged to my grandfather, and I found this little blast from the past: a Walmart (WMT) letter to shareholders from 1985, signed by Chairman and company founder Sam Walton.

As a child in the 1980s, I actually remember my grandfather proudly showing me a paper certificate for his shares of Walmart stock, and I remember the day he went electronic by handing the paper certificates to the trust department at the bank.  He wasn’t sure he trusted the system and made sure to photocopy his certificates before handing them over…just in case.

Paper stock certificates seem so anachronistic today in this age of online trading and instant liquidity. It makes me wonder how different the world of trading and investment will be when my future grandchildren are going through a drawer of my personal effects.

1985 Walmart Dividend Letter

The truth is, I’m not sure how beneficial instant liquidity is in building long-term wealth.  In fact, it’s probably downright detrimental.  When my grandfather bought his shares of Walmart, the high cost of trading discouraged him from short-term trading.  As a result, he was a de facto long-term investor, which ended up working out to his benefit as Walmart grew into one of the largest and most successful companies in history.   Long after my grandfather passed away, the cash dividends from the Walmart stock he accumulated in his lifetime continued to pay for the retirement expenses of my grandmother–and for my college tuition!  Had my grandfather had access to the instant liquidity of today, he might have been tempted to sell far too early.

My grandfather also practiced his own version of Peter Lynch’s advice to invest in what you know long before Peter Lynch became a household name.  He was an Arkansas boy–born and raised not far from Fort Smith–and he liked to invest in local companies that he could observe firsthand.  Walmart was one of those local companies; its headquarters in Bentonville is less than an hour and a half from Fort Smith by car.

I remember fondly my grandfather taking me to Fort Smith’s Walmart and buying me an Icee at the snack bar.  He liked to walk the aisles personally to see what Mr. Walton was doing with his money.  That might seem a little old fashioned today, but then, it’s still the approach taken by Warren Buffett and by plenty of long-term value investors.  If done right, it works.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Lorillard is a Bad Deal for Reynolds American Investors

And then there were two.  Two of the three remaining American “Big Tobacco” companies announced today that they would be merging: Reynolds American (RAI) will be buying Lorillard (LO) for $27.4 billion, including debt assumed.

Reynolds and Lorillard combined have sales of $13.3 billion and a market cap of $55.3 billion as of yesterday’s prices, leaving Altria (MO), the maker of Marlboro and other iconic brands in the number one spot.  Altria has annual revenues of $17.7 billion and sports a market cap of $84.5 billion.  Breaking it out by market share, the new Reynolds will control about 42% of the U.S. cigarette market, Altria will control about 51%, and smaller and foreign brands will make up the rest.

I’ll be brutally frank here: I question the value of this merger.  Reynolds is paying a high price for what is, we should remember, a business in terminal decline.  As of yesterday’s close, Lorillard shares traded for 21 times earnings and at a dividend yield of only 3.8%—quite low by the standards of a tobacco company.

Let me be clear on something: I’m not necessarily opposed to buying stocks in industries that are in terminal decline.  Under the right set of conditions—barriers to new competitors, dominant market position, minimal need for new capital investment, ample cash flows for dividends and buybacks, etc.—stocks with shrinking businesses can be excellent investments.

But the key here is price.  An investment in a shrinking company only makes sense if it is priced at a deep discount to the broader market.  And Lorillard—as implausible as this is—trades at a slight premium to the S&P 500.

Forgetting price for a moment, the Lorillard deal also brings with it regulatory risk.  85% of Lorillard’s sales come from its menthol brands, and these have become a lightning rod in recent years.  The U.S. Food and Drug Administration has already banned most flavored cigarettes and reported last year that it believes menthol cigarettes contribute to youth smoking.

Reynolds is effectively making a $27.4 billion bet that the FDA will leave menthol cigarettes alone.  That seems reckless to me; it’s a bet with modest upside and potentially disastrous downside.

Is there a trade to make here?

Yes: Sell Reynolds if you own it and move on.

I’m not the biggest fan of tobacco stocks at current prices.  I have shares of Altria and Philip Morris International (PM) that I have owned for years as part of a dividend reinvestment strategy, but I haven’t invested any significant new money in these positions in years because I see better income options elsewhere, such as in REITs.

If you feel you must own tobacco stocks, then I would go with Altria or Philip Morris International.  While neither are fantastic bargains these days, neither have the potential regulatory time bomb that Reynolds does in its exposure to menthol.  At time of writing, MO and PM sport dividend yields of 4.5% and 4.1%, in line with RAI’s 4.3%.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 


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