Many investment experts are partial to dividend-growth stocks, because the ability to increase dividends generally reflects strong fundamentals for a company. After all it’s difficult to raise dividends without earnings growth.
To get a take on the subject, we spoke with Simeon Hyman, head of investment strategy at ProShares Advisors, about its S&P 500 Dividend Aristocrats ETF NOBL. The fund tracks the performance of the S&P 500 Dividend Aristocrats index. A dividend aristocrat is a company that has lifted its dividend for at least 25 years in a row.
Related: Double play: Morningstar's 8 undervalued stocks that are raising dividends
The fund has annualized returns of negative 3.67% for the 12 months through Nov. 13, positive 5.68% for three years, positive 8.42% for five years, and positive 9.5% for 10 years. Those returns trail the Morningstar large-cap value index for one, three and five years, but beat it for 10 years.
Hyman says dividend growth stocks can provide a powerful core component of your portfolio. And he says the rules-based structure of his fund represents an advantage over actively-managed funds that might stray from their investment thesis. Here’s what he had to say.
TheStreet: What’s your investment philosophy?
Hyman: One thing that’s important is to keep your stocks stocks and your bonds bonds. Bonds generate income and act as a ballast. The objective of stocks is growth. If you get that confused, you might have bonds that don’t generate income and stocks that don’t generate growth.
TheStreet: Why choose an index fund over active management?
Hyman: We’re rules-based. We’re picking dividend-growth stocks, but by rules. It’s a systematic and disciplined way to get performance without the vagaries of active stock pickers. [An example would be value stock managers who stayed away from tech stocks until just before the dot.com crash of 2000.]
TheStreet: What’s the attraction of dividend-growth stocks?
Hyman: In stocks you have to look for growth. You can focus on different aspects of growth. One indication of quality stocks is dividend growth. When a company can consistently grow dividends over 25 years, that’s obviously a signal of quality. You get low leverage and strong cash flow.
It means companies must grow earnings, even in recessions. We have seen that in the earnings recession of the last three quarters. A dividend increase is forward looking. The company is telling you in has confidence in the future.
ProShares Advisors
TheStreet: Are there any other important themes in your fund?
Hyman: One is that the fund is equally-weighted. That’s important given how top heavy the S&P 500 index has become. [The S&P 500 is market-cap weighted, so the companies with the highest market-cap make up the biggest part of the index].
TheStreet: Is it important for investors to have dividend growth stocks in their portfolio?
Hyman: It makes for a powerful core position. It’s in the center of the style box. You’re getting the compounding of dividend growth over time. The yield on your cost basis gets big quickly.
The market has a 2%-3% yield now. With that yield increasing 10% to 12% a year, it doesn’t take long before you have a 4%-7% yield on your cost basis.
Dividend increases have a signaling aspect that stock buybacks don’t. Buybacks say you had good times last year. Dividend increases are a powerful forward-looking signal.
TheStreet: What’s your thought about high-yield stocks?
Hyman: They’re cyclical, and many don’t grow their dividends consistently. They will behave more like bonds. Dividend growers are more effective, better quality.
TheStreet: Can you discuss three of your fund’s stocks?
Hyman: 1. Cintas (CTAS) -) is the clear leader in uniform rentals. It commands 14% of the U.S. textiles rental market and 39% of the uniform rental market, greater share than its two largest competitors combined.
Cintas has steadily increased both gross and operating margins over the past decade, and by utilizing its operating leverage has doubled revenue and more than quadrupled earnings.
2. Roper Technologies (ROP) -) is a leading application and network software company for niche markets. It has transformed itself from an industrial manufacturer. It just increased its dividend by 10%. The company has increased its dividend every year since its IPO in 1992.
Since 2015, the company has spent $20 billion on acquisitions of predominately software assets, while preserving leverage to accommodate future deals.
3. West Pharmaceutical Services (WST) -) specializes in containment and delivery systems for injectable medications, supplying covid vaccines during the pandemic. lt has fortified competitive leadership with its relentless commitment to quality.
Its quality-driven ethos and market leadership have resulted in consistently higher earnings power, with operating and net margins that double the healthcare sector average.
The author owns shares of Cintas.
