Dividend investors know the value of owning stocks that make regular payments to their shareholders, and many have come to trust exchange-traded funds that specialize in finding top dividend stocks.
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The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) focuses on dividend stocks that pay above-average yields, and it has produced solid returns for its shareholders over time. The ETF scours the market to find the best opportunities for income-producing investments, and where it has found the best prospects is a bit surprising. The market's attitude toward dividends has changed dramatically in recent years, and the stocks that make up Vanguard High Dividend Yield's portfolio come from places that many wouldn't expect.
The top source of dividend stocks for the Vanguard High Dividend Yield ETF
The consumer-goods space has been a fertile ground for dividend stocks over the years. That's largely because the mature companies that dominate it are in a better position than many of their younger counterparts in other industries to return excess capital to shareholders. With fewer opportunities to effectively reinvest free cash flow in pursuit of faster growth, many of those consumer products giants instead simply boost their dividend payouts gradually over time.
Vanguard High Dividend Yield has about 15% of its assets in consumer goods stocks, with Procter & Gamble among its top holdings. P&G's more than 60-year streak of annual dividend increases is a testament to the power of the consumer sector to generate income, and Vanguard ETF shareholders get the benefit of its dividends as well as those of the dozens of other consumer stocks it owns.
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The up-and-coming dividend-paying sector
Where things get interesting, though, is with Vanguard High Dividend Yield's second-most important sector. Technology is a close runner-up, accounting for 14.3% of the portfolio. Microsoft is the fund's top holding.
For a long time, tech companies needed every spare dollar they could find in order to fund their growth. Now, though, as the sector matures, it includes a number of older tech giants that have accumulated billions of dollars in cash. Lacking tempting enough opportunities to invest those funds strategically, many have turned to dividends, and yields among some of the larger stocks in the tech space are well above the average yield for the U.S. stock market as a whole.
Returning to normal
The third-largest share of the Vanguard High Dividend Yield ETF comes from the financial industry. That sector currently accounts for 13.6% of the ETF's overall assets, and you'll find banks like JPMorgan Chase and Wells Fargo among the top five holdings of the fund.
What's particularly remarkable about financial stocks' position here is that they've made such a huge recovery after the crushing blow that the financial crisis dealt them in 2008 and 2009. In the wake of that crash, most bank stocks nearly eliminated their payouts, in some cases ending long streaks of increases and making the industry a non-entity on the dividend front. Yet as the economy bounced back, banks found ways to restore their dividends. While their yields aren't as high as they once were, major institutions are healthier financially than they were in the past. Given time, financials might well grow their payouts enough to reclaim the top spot in this and similar dividend-centric ETFs.
The Vanguard High Dividend Yield ETF combs the market for the dividend stocks with the best prospects for current income. Where it finds them changes over time. Staying on top of where such funds are discovering what they see as the strongest dividend stocks will give you a head start in your search for income investments for your own portfolio.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. 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.