Nirvana for Income Investors: Dividend Growth Meets Low Volatility

Income-oriented investors tired of negative real returns on high quality bonds are well aware that better yields are to be had in the stock market. Among the dividend payers in the S&P 500, the average dividend yield of 2.5% is more than a half percent more than a 10-year Treasury.

The big honkin’ trade-off is that to get that yield you have to take on the volatility that comes with investing in stocks. But that trade-off can be mitigated. In a mash up of the portfolio of an exchanged traded fund (ETF) that focuses on dividend growth and another that focuses on low volatility stocks, there was significant overlap. In a three-part series YCharts will run through eight stocks that are among the 10 largest holdings in the $14.1 billion Vanguard Dividend Appreciation ETF (VIG) and also show up in the $3.9 billion PowerShares S&P 500 Low Volatility ETF (SPLV). (The PowerShares portfolio holds just 100 stocks, so the overlap isn’t merely a function of portfolio breadth.)

Before we get to the stocks, a quick spin through the advantages of both strategies.

Over the long-term, dividend growth has proven to lead to strong performance. According to Ned Davis Research, over the past 30 years through 2012, the dividend growers (and initiators) in the S&P 500 have an annualized return of 9.5% compared to 7.2% for dividend payers that didn’t consistently boost their dividends. Stocks in the index that didn’t pay a dividend limped in with a 1.6% annualized gain.

And counter-intuitive as it may seem, low volatility stocks have a nice track record delivering market-beating returns over full market cycles. That last part is important. the low volatility approach will lag in strong bulls; its payoff is in the fact that it holds on better in down markets.

Okay, now to the stocks. In descending order of their weight in the Vanguard ETF: Wal-Mart (WMT), Coca-Cola (KO), Procter & Gamble (PG), PepsiCo (PEP), IBM (IBM), Exxon-Mobil (XOM), McDonald’s (MCD) and 3M (MMM).

For the Buffetteers: yep, four of the stocks are in Berkshire Hathaway’s (BRK.B) investment portfolio: Wal-Mart, Coca-Cola, Procter & Gamble and IBM. And for the curious: the two stocks in the top 10 of Vanguard Dividend Appreciation that don’t show up in PowerShares S&P 500 Low Volatility are Chevron (CVX) and United Technologies (UTX).

Pouring the eight stocks into a Watchlist and then looking at that list in the YChart Stock Screener tool where you can add and sort by dozens of metrics -- makes for some compelling slicing and dicing.

For current income, based on dividend yield, McDonald’s, Procter & Gamble and Coca-Cola led the pack, with IBM looking a bit yield anemic.

MCD Dividend Yield Chart

MCD Dividend Yield data by YCharts

But IBM has also been aggressively buying back its shares, reducing the total outstanding by 4.1% over the past year. That brings its total yield to a robust 5.7%. It’s also one of the strongest stocks in terms of dividend growth-as explained in the next article.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

Read more articles about: Investing Ideas  

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