Bear Market Dividend Conundrum: High Yield Or Dividend Growth?

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Daniel Grizelj

High Yield Or High Dividend Growth?

What qualities should a dividend investor focus on in their stock-buying during the current bear market?

As almost the entire market is selling off, dividend investors now have decisions to make with their scarce buying power. Should we prioritize high-yield dividend stocks or lower-yielding stocks with faster dividend growth?

It’s a question I wrestle with almost daily, as the current bear market has driven some dividend stock yields up into the double digits, but it has also offered rare discounts on some blue-chip dividend growers that almost never go on sale.

Of course, different investors will have different legitimate answers to this question.

Some investors are in the accumulation phase of their journey, still growing their account balances by adding cash from their paychecks on a regular basis. Others are in the withdrawing phase of their journey, using their investment income to fund their retirement.

Investors in or near retirement will likely be more interested in high yield stocks (although there are exceptions!). But for those who, like me, have at least 8-10 years to go before they wish to tap into their portfolio income to fund their living expenses, I think the better decision is to resist the temptation to buy high yield and instead to focus on faster dividend growth.

Specifically, I would advocate a quality dividend growth strategy.

Really, this is just another way of saying, “Own high-quality businesses with good management teams and strong growth prospects,” but with the added kicker of a growing dividend.

This strategy is better for long-term investors than a focus on the longest dividend growth track records, low volatility, or high yield. Let me show you why.

Total Returns

To illustrate the differences in total return performance between various dividend strategies, I’m going to use some ETFs that abide by each respective strategy.

First, let’s look at two dividend ETFs that have been around for about a decade:

  • Schwab US Dividend Equity ETF (SCHD)
  • Global X Super Dividend US ETF (DIV)

The former offers a moderate yield typically in the range of 3-3.5% as well as faster dividend growth, while the latter offers a much higher dividend yield of about 7% but with little to no dividend growth.

SCHD’s top holdings are names like Merck & Co. (MRK), PepsiCo (PEP), and Home Depot (HD), while some of DIV’s top holdings are Shell Midstream (SHLX), Gilead Sciences (GILD), and Iron Mountain (IRM).

By and large, SCHD’s holdings have lower starting yields and higher dividend growth rates, while DIV’s holdings exhibit the opposite traits.

How did each strategy work coming out of the pandemic?

Well, we can see how each has performed on a price basis from mid-February 2020, just before the pandemic began, to the end of 2021, when the bull market ended.

Chart
Data by YCharts

SCHD (dividend growth) crushed the performance of DIV (high yield) by a 47-percentage point differential.

But, of course, high yield investors are primarily buying for the generous dividend, so let’s see how the two compare with dividends included in the returns picture (i.e. total returns).

Chart
Data by YCharts

Well, with dividends included, DIV’s total returns did come in barely positive between mid-February 2020 and the end of 2021. But SCHD still stomped it at a 44-percentage point differential.

I’m not saying this to disparage high yield in general nor the DIV ETF specifically. Just as there are some scenarios where value outperforms growth, there are also scenarios where high yield outperforms high dividend growth. High yield is basically equal to value, only with a dividend component.

This year, as value has outperformed growth, so also has high yield outperformed dividend growth from a total returns standpoint:

Chart
Data by YCharts

But to be fair, the situation the economy has endured over the last few years, considering both the pandemic and the unprecedented level of stimulus and money supply growth, is unusual.

Let’s take a look at how dividend growth fares against high yield through a different recession – the Great Financial Crisis of 2008-2009.

For this, we’ll need to use different ETFs, because SCHD and DIV didn’t exist yet. Instead, we’ll use these two ETFs for their respective strategies:

  • Vanguard Dividend Appreciation ETF (VIG) – Dividend Growth
  • WisdomTree US High Dividend ETF (DHS) – High Yield

While VIG tends to have a dividend yield ranging from 2-2.5%, DHS tends to have a dividend yield of between 3.5% and 4%. Back in 2008, though, VIG had about the same dividend yield while DHS sported a yield range of about 5.5% to 6%, making it truly “high yield.”

Here’s how the two fared through the worst segment of the GFC:

Chart
Data by YCharts

From September 2008, just before the stuff started to hit the fan, to March 2009, when the stock market bottomed, VIG (dividend growth) outperformed DHS (high yield) by about 15.5 percentage points.

The return differential is only slightly better if you add in dividends, narrowing the differential by about half a percentage point:

Chart
Data by YCharts

If we zoom further out to include the 2010s bull market, however, the picture gets a little more complicated. From September 2008 to February 2020, VIG did outperform DHS on a total returns basis, but only because of its outperformance during the GFC.

Chart
Data by YCharts

If you were to measure during the bull market alone (March 2009 to February 2020), DHS actually produced higher total returns than VIG.

But that’s just total returns. Let’s turn to a topic more near and dear to my own investment strategy: income growth.

Yield And Dividend Growth

For this section, I’m going to use four ETFs, only one of which is new: the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD).

I pick these four ETFs not only because they each have their own unique strategies, but because they each have their own typical dividend yield ranges:

Chart
Data by YCharts

  • VIG typically trades at a dividend yield of about 2-2.5%.
  • SCHD typically trades at a dividend yield of about 3-3.5%.
  • SPHD typically trades at a dividend yield of about 4-4.5%.
  • DIV has the biggest yield fluctuations but typically ranges between 5.5% and 7.5%.

But as experienced investors know, dividend yield is only one component of returns dividend investors should examine. Another, perhaps more important in the long run, factor is dividend growth – how much the dividend payment grows year after year.

Let’s take a look at how each of our four dividend ETFs performed on dividend growth from 2014 to the present:

Chart
Data by YCharts

Unsurprisingly, the highest yielding ETF performed the worst here with a ~14% lower dividend in 2022 than it had in 2014. And though SPHD’s dividend growth held up well during the bull market from 2014 through 2019, it dropped and underperformed once the pandemic hit.

Interestingly, though VIG and SCHD exhibited similar levels of dividend growth from 2014 through 2018, SCHD’s dividend growth has been outperforming since around 2019. Why is that? One would certainly assume that the lower-yielding ETF would have higher dividend growth.

Well, VIG tracks the S&P Dividend Growers Index, which includes companies that have grown their dividends for the last 10 consecutive years while excluding the top 25% highest-yielding eligible companies. That caveat excluding the highest-yielding quarter of eligible 10-year dividend growers helps to explain VIG’s persistently low dividend yield.

The more pertinent point about why VIG’s dividend has slightly underperformed that of SCHD, in my estimation, paradoxically concerns the 10-year dividend growth track record. Ten years is just the minimum. VIG includes many companies that have been growing their dividends a lot longer than that.

At some point, company management teams prioritize maintaining that long dividend growth streak, even if it means simply raising their dividend by a penny or a fraction of a penny per share. When faced with a difficult economic environment, many of these long-term dividend growers will maintain their growth streak but at a very slow pace.

SCHD requires its holdings to have at least 10 years of consecutive dividend payments but only 5 years of consecutive dividend growth.

SCHD also makes a few other interesting adjustments that tend to increase the quality of holdings, in my view. For instance, it more heavily weights companies with low debt and/or high operating cash flow as a share of total debt. It also weights more heavily companies that have higher return on equity metrics. After that, it weights by dividend yield.

In other words, among the universe of stocks that have paid dividends for 10 years and grown them for the last five, SCHD prioritizes quality first and yield second. But, unlike VIG, SCHD does not purposely shun the higher yielders.

As it turns out, high-quality stocks that pay dividends are the ones that end up producing the fastest dividend growth in the long run.

If you had purchased SCHD at the beginning of 2014 at its market price of around $36.25, you would enjoy a yield-on-cost of 6.8% today. Comparatively, here are the YoCs (TTM dividends divided by beginning-of-2014 market price) for the other ETFs:

  • VIG: 3.8%
  • SPHD: 6.0%
  • DIV: 4.7%
  • DHS: 5.3%

SCHD’s yield-on-cost since 2014 of 6.8% beats the competition by a country mile!

How does the ETF do it? By focusing on a combination of quality and moderate yield. Length of dividend growth streak doesn’t do it, as we see in VIG. Nor does low volatility, as we see in SPHD. And, obviously, nor does high yield.

Oh, and by the way, this strong combination of quality, moderate yield, and dividend growth also results in the strongest total returns over time. We see that when comparing SCHD to the four other ETFs we’ve used above:

Chart
Data by YCharts

Bottom Line

Everything is selling off this year, which means that all kinds of stocks are discounted to their typical price ranges and valuations. That includes dividend stocks, where both high yield and dividend growth names have become attractive.

While investors in or near retirement who are primarily interested in maximizing current income may wish to target higher yielding stocks, even if dividend growth is slow, I would argue that investors with 8-10 years left until they need to tap into their investment income would be better off buying high-quality, moderate yielding, fast dividend growing stocks.

Those are more likely to yield more income on one’s cost basis in 8-10 years’ time, and they are also more likely to achieve better total returns.

Do I take my own advice? For the most part, yes.

While I am buying some high yielders like blue-chip business development company and monthly dividend payer Main Street Capital (MAIN) as well as diversified net lease giant W.P. Carey (WPC), most of my buying is concentrated in picks like those I highlighted in “Bear Market Buying Strategy: Focus On Quality (10 Dividend Growth Picks).”

Picking a top three from that list would be extremely difficult, but if I had to do so I think the three I’d pick are:

  • Broadcom (AVGO) – Diversified semiconductor producer that has attractive exposure to various growth industries like cloud computing, smartphones, and factory automation. Chips are the building blocks of almost every new technology.
  • Crown Castle (CCI) – Telecommunications REIT that owns 40,000 cell towers, 115,000 small cell nodes, and 40,000 route miles of fiber that benefits from the massive investment in 5G from providers without having to invest its own money.
  • EastGroup Properties (EGP) – Sunbelt-focused industrial park owner/developer with great locations in urban areas that are in high demand and should continue to be so for decades to come.

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Data by YCharts

To each his or her own, of course.

But I think investors could hardly do wrong in the long run by investing in high-quality, moderate yielding dividend growth stocks right now. It’s a rare and extremely attractive buying opportunity, in my opinion, that should produce better total returns and more income per invested dollar in 8-10 years than any other dividend strategy.

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