A Look at Another Dividend Growth Index

One fund I am thinking about buying is the iShares Core Dividend Growth ETF (DGRO) (ETFDb page here, iShares page here).  It tracks the Morningstar US Dividend Growth Index.

You can get the methodology docs for Morningstar indexes here. I do not think you can get to their index page from their main page or vice versa. I had to google to find it. Their methodology documents have some graphics summarizing the base criteria, and are probably the easiest methodology documents that I have gone through so far (out of the three firms’ documents).

The Morningstar US Dividend Growth Index is a subset of the Morningstar US Market Index. The Morningstar US Market Index has the following criteria:
– It includes mostly common stocks, REIT, or tracking stocks which trade on one of the three major U.S. exchanges: The New York Stock Exchange, Nasdaq, or the NYSE Market LLC. It may include ADRs if there is no corresponding stock.
– Each security must have no more than 10 nontrading days in the prior quarter
– Each security must be in the top 75% of remaining companies based on liquidity score, determined by trading volume over the prior six months.

The Morningstar US Dividend Growth Index takes the Morningstar US Market Index, and includes stocks with the following criteria:
– It only includes stocks that pay qualified income as dividends (so REITs are out)
– A stock’s dividend yield must not be in the top 10% of the parent index (so companies with super high yields are excluded)
– A stock must be currently paying dividends and have at least five years of uninterrupted annual dividend growth
– “Security must have a positive consensus earnings forecast and a payout ratio less than 75%.”
– If a stock does not raise or decrease its dividend, but does execute a share buyback, it can remain in the index

There are a few things that I like about this index, and a few things that I do not like.

Obviously, I like the fact that it is a dividend growth index. Five years is a short threshold, but it’s better than none. I also like that they exclude stocks with the highest yields. Sometimes a high yield can be a sign of trouble. I think more dividend indexes should do this, particularly those (like the FTSE High Dividend Yield Index) that are not dividend growth indexes. This exclusion becomes less necessary with a higher threshold.

I do not like that it considers buybacks as some sort of equivalent to dividend increases. A lot of people say that buybacks “return cash to shareholders”, but that is not true. It’s just another example of the Greater Fool Theory. Dividends are actual cash to shareholders, not “I hope somebody will buy it for more than I did”, which does not always work. And as we say during the Great Recession, will probably not happen when you really need it to happen. I think buybacks are a plague on the financial ecosystem. We got along fine without them until 1981, I think we should go back to that. After all, it is the “Morningstar US Dividend Growth Index”, not the “Morningstar US Dividend Growth Or Something That Only Stupid People Think Is Close Enough Index”. Either a company increases its dividend, or it does not. End of story. If I wanted to deal with the stupidity of buybacks, then I would find a buyback ETF.

I am also leery of this criterion: “Security must have a positive consensus earnings forecast and a payout ratio less than 75%.” First off, whose consensus? I do not like the idea of someone’s guesses forming the basis of my retirement. And I am not too sure about the payout ratio criterion either. While a lower ratio is better, sometimes companies have to go into debt to maintain their dividend, and have better ratios when things turn around. For example, I did not buy shares in Old Republic International (ORI) when I started looking at DGI stocks because although they were increasing their dividend, they were losing money. But now they seem to be doing fine. How will this index do in a recession?

How this index would do in a recession is a concern to me. The methodology document states: “The inception date of the index is April 7, 2014, and the performance inception date of the index is December 19, 2003, when the first back-tested index value was calculated.” However, I have not been able to find any performance data for this index going back to 2003. Plus, since they are using consensus forecasts, it is not truly rules-based, so backtesting may not be too useful.

So far, I think I like the NASDAQ US Broad Dividend Achievers Index (DAA) index the best, but its ETF has pretty high costs.

“Morningstar” and other terms with the word “Morningstar” (like the names of their indexes) are trademarks of Morningstar, Inc.

Big Jim thinks that an index should not rely on someone’s opinion.

Painting of the Resurrection (“Noli me tangere”, aka “I’m too sexy for you”) by Giotto di Bondone (1267 – 1337), assumed allowed under Fair Use.

Too Damn High” image from ImgFlip, based on “The Rent Is Too Damn High” meme, assumed allowed under Fair Use.

Post created on 2019-04-28_20:22:41, last modified on 2019-04-29_2:21:23

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