The quality factor is often associated with dividends and there are plenty of exchange traded funds that offer investors exposure to a combination of quality and dividend-paying stocks. That group includes the FlexShares Quality Dividend Index Fund (NYSEArca: QDF).
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QDF emphasizes the quality factor, of which a company’s ability to generate free cash and dividend growth and stability are integral tenants. Another element that has been critical to QDF’s success is the emphasis on management efficiency and a company’s ability to generate cash.
Company stocks that issue high dividend yields can be masking their distressed books or may not be sustainable and are heading for dividend cuts. Consequently, these quality dividend ETFs try to limit the impact of these value traps by requiring a history of sustainable dividend growth.
QDF features a heavy cyclical tilt, which can be a positive trait in advance of higher U.S. interest rates. The financial services, technology and consumer discretionary sectors combine for nearly half of the ETF’s weight. Conversely, QDF’s exposure to the rate-sensitive telecom and utilities sectors is relatively modest as is the fund’s allocations to the downtrodden energy and materials groups.
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“The result is a portfolio that at a high level doesn’t look all that dissimilar to the S&P 500 but is much cleaner on the inside. The Quality Dividend ETF is currently overweight financials, which could benefit from an impending Fed rate hike, and utilities, an area of the market traditionally more conservative while delivering above average yields. It’s underweight primarily in the healthcare and technology sectors,” according to a Seeking Alpha analysis of QDF.
QDF screens for management efficiency, profitability and cash flow. Each company has to show management efficiency, or firms that efficiently deploy capital and make smart financing decisions. Companies with wider profit margins are better positions to grow and maintain dividends than those with slimmer margins. Additionally, firms that can meet debt obligations and day-to-day liquidity needs are better capable of maintaining dividends.
“Clean, quality dividends are more important today than maybe any time since the financial crisis. Earlier this year, Fitch raised its 2016 forecast on high yield debt defaults up to 6% overall, while saying that defaults in the troubled energy sector could surpass 20%. While dividend payments on equities and principal repayments on debt aren’t the same thing, it does suggest that the overall economic environment is making payments to shareholders a little less certain,” adds Seeking Alpha.
FlexShares Quality Dividend Index Fund
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
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