A Fine Idea Among Dividend ETFs

After starting the year as one of the premier destinations for income investors, high-yield dividend stocks have recently been under pressure. Once beloved income-generating sectors, namely consumer staples and utilities, fell out of favor as financial markets priced in increasing chances of the Federal Reserve potentially raising interest rates nexA Fine Idea Among Dividend ETFst month.

While there is a clear dichotomy for income investors when it comes to sectors such as consumer staples and utilities that being the yields in those groups are impressive, but the sectors are notoriously rate-sensitive a compelling case for dividend stocks remains. In particular, the case is compelling for dividend growers over high-yield fare.

The iShares Core Dividend Growth ETF (iShares Trust (NYSE:DGRO) is one exchange-traded fund that can help investors access a basket of dividend growers.

Index And Strategy

DGRO follows the Morningstar US Dividend Growth Index, which requires constituent firms have a minimum of five years of uninterrupted dividend growth. The index also purposefully avoids stocks with high and potentially unsustainable dividend yields by excluding firms with yields that rank in the top 10 percent of the eligible inclusion universe and only companies with a payout ratio of less than 75 percent can be included, according to Morningstar.

High-Yield, Dividend Stocks And Rate Increases

High-yielding dividend stocks typically suffer more when rates rise than dividend growers quality companies with enough free cash flow to sustain dividend increases over time, said BlackRock in a recent note. Yet even many of these stocks could generate positive returns in a gradually rising yield environment. Thanks to the power of compounding dividends and earnings growth, valuations of global developed stocks would need to fall by roughly 30 percent over the next five years to generate negative returns for investors, our return assumptions suggest. We view this as unlikely.

Holdings And Allocations

While consumer staples chime in at 15 percent of DGRO's weight, making that the ETF's second-largest sector weight, rate-sensitive utilities and telecom stocks combine for less than five percent of DGRO's 425-stock lineup.

DGRO taps cyclical dividend growers, stocks that should remain durable if the Fed turns hawkish, by way of a more than 28 percent combine allocation to financial services and industrial stocks. Rising inflation also positively spotlights the advantages of dividend growers.

We see higher inflation expectations, rather than rising real yields, driving rises in nominal bond yields. This bodes well for dividend growers and strengthens our preference for these stocks. They tend to be more resilient amid rising rates and outperform when rising rates are driven by higher inflation, our analysis finds. Dividend growers are typically able to raise prices, and dividends, in reflationary environments, added BlackRock.