Will interest rates continue their recent ascent?
If so, many investors will come to question the wisdom of holding dividend-paying stocks. After all, bondsand CDs are virtually riskless, and if they sport more attractive yields, why bother with riskier stocks?
The simple reason: Interest rates (such as on the 10-year Treasury note) are unlikely to move past 4%,as I noted recently.
Any stock with a yield above that threshold should still hold appeal — as long as that dividend doesn’t look vulnerable to a reduction or elimination in a changing economic environment.
Yet there is a whole different type of income-producing stocks that fail to meet that 4% yield threshold but should still hold great appeal. These are the stocks with fairly low yields right now but look poised for robust growth, which should set the stage for future yields well above 4%, using today’s prices as abasis.
Notes From The Guru
Over the past six months, I’ve been eagerly awaiting the latest newsletter issues from my colleague Amy Calistri, author of StreetAuthority’s Daily Paycheck. Amy has been spelling out a game plan for how to deal with the inevitable rise in interest rates that may now be underway, helping readers to separate winners from losers in a higher-rate environment.
In her most recent issue to subscribers, Amy focuses on an exchange-traded fund (ETF) that should fare quite well, even as rates rise higher. The current yield on this ETF is around 3.5%, which is below the 4% level I noted earlier.
Yet here’s the rub: This ETF is chock-full of companies that are boosting their dividends at a fast pace, and a 3.5% yield today could easily morph into a 5% yield in a few years and a 7% or 8% yield in half a decade.
The combination of solid current and future dividend streams and potentially robust priceappreciation makes me think Amy has delivered another winning pick to her subscribers.
There’s another reason to focus on dividend growth: “Companies with a long history of dividend growth display high returns on equity (ROE),” according to WisdomTree’s head of research, Jeremy Schwartz. The data bear that out: The companies in the widely followed NASDAQ US Dividend Achievers Index had a 22% annual ROE over the past 10 years, according to Schwartz, compared with 13% annual ROE for all companies in the S&P 500.
I can’t share Amy’s dividend growth-oriented ETF pick, as that would be unfair to her current subscribers, but I can share some similar investing options that capitalize on this theme.
WisdomTree — which has pursued the dividend angle for a number of years with funds such as WisdomTree Emerging Mkts Small Cp Div Fd (NYSEARCA:DGS) and the WisdomTree LargeCap Dividend Fund (ETF) (NYSEARCA:DLN) — recently pursued the growth angle with a newly launched ETF, the WisdomTree U.S. Dividend Growth Fund (NASDAQ:DGRW).
This fund uses an index-based approach to select the top companies in a 1,330-stock universe in termsof dividend growth, sustainability of those dividends (in terms of a payout ratio above 1.0) and current yield. Tech stocks represent the largest weighting of any sector, at around 20%.