Dividend-paying stocks have been in focus in recent years—many income seekers have turned away from low-yielding fixed income instruments and are looking to equity markets for an attractive level of income. After the rise of interest rates at the end of 2018, a continuing search for yield is expected. However, this search for yield will probably be guided by a focus on quality, and it likely will be against a backdrop of future rising rates.
Among different kinds of income-focused equity indices in the market, the Dow Jones U.S. Dividend 100 Index takes a unique approach. The index not only seeks to track stocks with consistent dividend payouts, but it also applies quality assurance for the sustainability of yields. It seeks to achieve “quality yields” by requiring stocks to have paid dividends for a minimum of 10 consecutive years, and by ranking stocks by a composite score calculated from the cash-flow-to-total-debt ratio, return on equity (ROE), dividend yield, and five-year dividend growth rate.
A focus on dividend growth in an environment where market participants are concerned about rising rates is important. Typically, high-yield equity strategies are biased toward rate-sensitive sectors, which pay out high yields because of the leverage that they can take on (mainly because of mature business models, e.g., utilities). Such entities are exposed when rates rise. Selection based on dividend growth ensures that firms that can develop their business and increase their payouts are favored in the selection process. Such businesses often tend to be well-managed companies, from both capital structure and operational perspectives.
Also differentiating the Dow Jones U.S. Dividend 100 Index from other dividend strategies are its strict size and liquidity screens and its weighting method, which is based on a modified market capitalization approach. These attributes aim to increase tradability, reduce the influence of smaller and more-distressed stocks on the portfolio, and attain a certain degree of diversification by capping sector- and stock-level exposures at 25% and 4.5%, respectively. A weighting method based on modified market capitalization also has the potential to lead to a lower turnover than alternatively weighted income indices that primarily weight based on yield or total dividends.