High dividend stocks were all the rage in 2011 and 2012, as yield-starved investors hunted for income where they could find it. Yet two of the sectors best known as “high yield” sectors—utilities (XLU) and telecom (XTL)—are on track for a sub-par 2012 (the utilities sector is actually negative for the year). It’s not particularly hard to see why. For slow-growth sectors, both have become expensive relative to the broader market.
Utilities yield just over 4% as a sector, which is nearly double the yield on the S&P 500 and more than double the yield on the 10-year Treasury. But in terms of cash payout, you’re not going to be getting significantly more next year than you did this year. Utilities do grow their dividends over time, but they tend to do so slowly.
Don’t get me wrong; I’d prefer to take a basket of utilities stocks, equity risk and all, over most bonds at current yields. The uncertainty of the equities markets beats the virtually guaranteed losses that bond investors face, particularly after inflation.
Yet the yield is only part of the story. Dividends are about more than just current income. They are about quality. Which brings me to my recommendation this week: the Vanguard Dividend Appreciation ETF (VIG).
Fig. 1: VIG vs. SPY
For a “dividend focused” ETF, VIG yields a relatively puny 2%. But unlike bond coupon payments or slow-growth utilities or telecom stocks, VIG’s cash payout will almost certainly be significantly higher in the years ahead.
You see, in order to be a holding of VIG, a company has to have at least ten consecutive years of rising dividends behind it. These are growth stocks, not cash cows for widows and orphans.
Yet at the same time, the holdings are generally high enough quality to be held by widows and orphans. Think about it. If you’re able to raise your dividend throughout the 2008-2009 meltdown and recession, your company must be bulletproof.
VIG is stuffed full of the highest-quality companies in America; Wal-Mart (NYSE:WMT), Coca-Cola (NYSE:KO) and IBM (NYSE:IBM) are its three largest holdings, to drop a few names. And interestingly enough, utilities and telecom together make up less than 2% of the portfolio.
VIG is not an ETF that I recommend you trade aggressively. VIG—and the stocks that comprise it—is the sort of investment that you should use as the foundation of your core portfolio.
As we start a new year, consider ditching any S&P 500 index funds you might own and replacing them with VIG. And for the developed international allocation of your portfolio, you might consider the PowerShares International Dividend Achievers ETF (PID). It’s built on the same principles as VIG but covers developed non-U.S. markets.
Disclosures: Sizemore Capital is long VIG, WMT and PID.
About the author:
Mr. Sizemore has been a repeat guest on Fox Business News, quoted in Barron’s Magazine and the Wall Street Journal, and published in many respected financial websites, including MarketWatch, TheStreet.com, InvestorPlace, MSN Money, Seeking Alpha, Stocks, Futures and Options Magazine, and The Daily Reckoning.