There is a reason that Warren Buffett buys stocks that pay dividends but doesn’t issue them to Berkshire Hathaway shareholders. Collecting dividends is a highly lucrative passive investing strategy and as dividends are increased annually, the opportunity to generate enormous returns on principal exist.
It’s been reported that his yield on his original principal invested in Coca Cola amounts to almost 60% annually now. That’s because since he first bought the dividend amount has continually increased.
So how can you get in on the action?
The Vanguard’s Dividend Appreciation ETF (VIG) is a passively managed fund that tracks the S&P US Dividend Growers index.
Its specific focus is on companies that have a history, like Coca Cola, of increasing their annual payouts. To be included in the sample group, a company must have increased its dividend for a full ten years consecutively.
If you’re a dividend investor looking for growth, this might just be the fund for you.
The Bull Case for Dividend Growth Investing
Before looking at VIG specifically, let’s take a look at the thesis behind dividend growth investing.
Buying shares of companies that consistently raise their dividends is a time-tested way to build long-term income.
Each time a company raises its dividend, investors who already hold their shares see a larger yield on their cost basis.
Over time, the effect of consistent dividend increases can result in very large yields compared to an investor’s initial purchase cost.
To illustrate this effect, consider Warren Buffett’s famous investment in Coca-Cola. The noted proponent of buy-and-hold investment strategies paid $1.3 billion for his stake in the company throughout the 1980s and 1990s.
Today, the 400 million shares held by Buffett’s Berkshire Hathaway conglomerate pay out $776 million in annual dividends. That represents a nearly 60% yield on the initial cost of the investment, a number that only increases each year as Coca-Cola continues to raise its dividend.
This strategy has proven extremely successful over many years, including during market downturns. The S&P 500 dividend aristocrats, for example, have handily outperformed the broader index in terms of total returns while keeping volatility to a minimum.
Since 2005, these high-quality dividend stocks have beaten the S&P 500 overall in 80% of major quarterly downturns.
How Has VIG Stacked Up to the Broader Market?
Over the last several years, dividends have had less focus put on them as investors flocked to high-growth stocks. Before deciding to buy a dividend growth fund like VIG, it’s important to see how the fund has performed in comparison to the broader market.
A good way to do this is to compare VIG to other major Vanguard funds. Over the last decade, VIG has returned an annual average of 10.9 percent.
VOO and VYM have returned 12.4% and 9.5% over the same period, respectively. VOO tracks the S&P 500, and VYM focuses on high-yield dividend stocks.
Beyond price appreciation, there are also dividends to consider as part of total returns. VIG currently yields 1.8%. This is slightly above the 1.4% yield offered by VOO but still well below the 2.9% yield of VYM.
Due to its composition, however, VIG’s dividends are likely to increase at a faster pace than either of the other funds.
Taking all of this into account, it’s fair to say that VIG occupies a place somewhere in between the growth power of the S&P 500 and the immediate income potential of the legacy high-yield stocks that make up VYM.
VIG looks to be in a good position to deliver better dividends than the S&P 500 while appreciating at a faster rate than the highest-yielding stocks in the market.
Is VIG Priced Correctly?
Of course, investors also have to be conscious of the price they pay for a stock or fund.
At the moment, VIG trades at 23.1x its trailing 12-month earnings. This is slightly lower than VOO, which trades at 24.7x earnings. This places VIG slightly below the average of the S&P 500 index, indicating that its pricing is more or less in line with the market as a whole.
With that said, it’s important to keep in mind that stocks in general appear to be historically expensive right now. Though market conditions are generally favorable, stocks currently trade at very high multiples that may make them vulnerable to an eventual correction.
What Stocks Are In VIG ETF?
Only companies that have raised their dividends for 10 consecutive years are included in the Vanguard Dividend Appreciation ETF (VIG).
As with any ETF, it’s important to make sure that VIG offers a decent degree of diversification before investing in it. The fund is somewhat concentrated in information technology and financials, which make up 22.1% and 20.2% of its holdings, respectively. Consumer staples, the third-largest category, account for another 11.8%.
On a company-by-company basis, though, VIG is reasonably well-diversified. No single stock makes up more than 3.9% of the fund’s holdings, and there are 340 stocks in total.
As such, investors get a reasonable degree of protection from any one company experiencing a downturn.
Is VIG a Good Buy at the Moment?
In addition to pricing in line with current market trends and decent diversification, there are strong reasons to buy dividend growth ETFs like VIG at the moment.
To begin with, dividend stocks appear to be at the beginning of an upward cycle. With growth stocks plateauing amid concerns over valuation and the effect of higher interest rates, dividend stocks are gaining popularity among investors as a safe choice for generating returns.
Another strong case for buying VIG is the recent trend of mega-cap tech companies putting greater focus on dividends.
VIG’s top two stocks are Microsoft and Apple, making up a combined 7.7% of its holdings. As technology companies move to pass more of their cash flows along to investors via quarterly distributions, these companies and others like them could provide outsized dividend growth opportunities for VIG investors.
VIG looks like a fairly good buy at the moment. The fund is well-positioned to take advantage of renewed investor interest in dividend stocks and trades at a reasonable price. For investors interested in the income opportunities that come with long-term dividend growth, VIG presents a good approach for buying a curated and diversified portfolio of the stocks most likely to increase their payouts in the years to come.
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