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Dividend ETFs: Here’s One Delivering High Yield Without a Risky Utility Bet -- its 5 Top Stocks

With an average yield of 4%, the utility sector is an obvious place to prowl for income.

Problem is, the ever-growing army of yield seekers has made the sector an expensive place to invest.

The current PE ratio for the utility sector in the S&P 500 is 15.6, exceeding the 13.1 PE for the broad market benchmark. In “normal” times, utilities, with their slower growth prospects typically sell at a 25% discount to the market PE.

That makes a an ETF such as iShares Dow Jones Select Dividend ETF (DVY), with about one-third of its nearly $11 billion in assets riding on the utility sector, a lot dicier than I imagine many investors realize. My guess is they were hooked at the 3.5% yield and haven’t bothered to take a look under the hood at how the ETF is invested.

At the other extreme is the $11 billion Vanguard Dividend Appreciation ETF (VIG). With its focus on dividend growth, rather than current yield payouts, it has just 1% invested in the pricey utility sector.

For long-term returns, it’s clear that Vanguard Dividend Appreciation’s focus on dividend growth has its charms.

DVY Total Return Price Chart

DVY Total Return Price data by YCharts

But if you’re stuck on a high current payout, well, Vanguard Dividend Appreciation is not going to float your boat; its current 2.1% yield is well below the 3.5% for the iShares Dow Jones Select Dividend ETF.

A new entrant in the dividend ETF space looks like an intriguing goldilocks solution that delivers a strong yield while also paying attention to growth factors for the underlying stock and the dividend itself.

Schwab U.S. Dividend ETF (SCHD), launched last fall, has a current yield of 3%. And it pulls that off with just 3.2% invested in the utility sector. The ETF does its dividend hunting among stocks in the Dow Jones Dividend 100 index. To be eligible for that index a stock much have a 10-year track-record of paying out dividends. The next cut is to rate stocks on four criteria: cash-flow relative to total debt, return on equity, dividend yield and 5-year dividend growth.

The five largest current holdings of Schwab U.S. Dividend ETF are Wal-Mart (WMT), Johnson & Johnson (JNJ), Chevron (CVX), ExxonMobil (XOM) and Coca-Cola (KO). The lowest five-year annualized dividend growth rate among the five is 7.6% (ExxonMobil). To be clear, that’s more than double the long-term inflation rate. No bond offers that sort of inflation protection.

WMT Dividend Chart

WMT Dividend data by YCharts

By comparison, among the three largest utility stocks in the iShares Dow Jones Select Dividend Select ETF, only Entergy (ETR) has strong dividend growth averaging 9% over the past five years; Integrys (TEG) has 3.6% dividend growth; ) and DTE Energy (DTE) 2.3% dividend growth. Those aren’t exactly inflation whippers.

Helping Schwab U.S. Dividend ETF grind out that nice 3% yield is a rock-bottom fee charge of 0.17%. That’s cheaper than the 0.40% annual expense ratio charged on the iShares Dow Jones Dividend Select SPDR etf. In today’s low-income world, keeping an extra 0.23% in your pocket is a nice advantage.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Read more articles about: Investing Ideas  

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