Better Buy: Vanguard High Dividend Yield vs. Vanguard Dividend Appreciation

By Dan Caplinger Markets Fool.com

Dividend stocks have taken the investing world by storm, and exchange-traded funds that specialize in dividend stocks are more popular than ever. Two Vanguard ETFs focus on dividend stocks: the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) and the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG). Although both of these funds focus on dividends, they take a different approach that has led to disparities in performance and income over time. Dividend investors who are hungry for income want to know which of these two ETFs is better suited to their needs. Let's look more closely at how these two Vanguard dividend ETFs match up right now on some key metrics to see which could be the better buy.

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Valuation and stock performance

Both Vanguard High Dividend Yield and Vanguard Dividend Appreciation have produced solid returns for investors, but Vanguard High Dividend Yield has outperformed its fund-family sibling by a slight margin. Over the past year, High Dividend Yield is up 23%, compared to Dividend Appreciation's 19% rise. In the past five years, High Dividend Yield enjoys a 13.6% to 11.2% lead in average annual return.

From a valuation standpoint, the stocks that High Dividend Yield owns are also just slightly cheaper than the holdings of Dividend Appreciation, at least on a trailing earnings basis. High Dividend Yield's holdings have an overall earnings multiple of 22, compared to a 23 multiple for Dividend Appreciation. That's not much, but it suggests that even with its stronger recent performance, High Dividend Yield hasn't gotten clearly overpriced compared to its fellow dividend ETF.

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Dividend income

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As its name suggests, High Dividend Yield has also done a better job of returning current income to shareholders than Dividend Appreciation. In terms of current yield as defined by the Securities and Exchange Commission, High Dividend Yield pays 3.09%, compared to just 2.14% for Dividend Appreciation.

In addition, both ETFs have managed to produce substantial growth in dividends over the years. High Dividend Yield paid a total of $1.327 per share in dividends in 2011, compared to $2.206 per share last year, for growth of nearly two-thirds. Dividend Appreciation, which has a specific goal of boosting dividend income over time, saw its total payout rise from $1.172 to $1.826, which is only a 56% rise. That gives High Dividend Yield a solid edge in the dividend department -- something that's unexpected, given the fact that Dividend Appreciation is supposed to emphasize dividend growth more highly than its dividend ETF peer.

Growth and potential risk

Dividend stocks generally have both growth prospects and potential risk, but the mix of stocks inside an ETF can give some clues as to how the risk-reward proposition balances out. High Dividend Yield has adopted more of a shift toward the value side of the spectrum, with relatively high concentrations in financials and energy stocks. That has paid off lately, because the energy sector has rebounded convincingly in the past year following the bottoming-out of crude oil prices in early 2016. In addition, the financial sector has soared recently, spurred by the 2016 presidential election and the prospects for less stringent regulation that could add a further boost to profits from rising interest rates. On the growth side, High Dividend Yield has extensive exposure to technology stocks, and they could continue their solid run in 2017 as well.

At Dividend Appreciation, different sectors receive more emphasis. Consumer goods and services make up nearly two-fifths of the ETF's portfolio, making it highly dependent on the behavior of consumers. The industrial sector also gets substantial representation in the fund, making up a quarter of its total assets. That gives Dividend Appreciation's holdings an interesting mix of defensive all-weather stocks and highly cyclically linked industrial stocks. Industrial stocks in particular have rebounded lately as some see the U.S. economy accelerating, but cyclical opportunity also brings cyclical risk in the long run.

Based on these factors, between the two ETFs, High Dividend Yield has offered better returns and greater dividend yields at a similar valuation while arguably having similar or less risk in comparison to its growth potential. That makes High Dividend Yield look like the better buy for dividend ETF investors right now.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.