Navigating Volatile Markets Via Dividend Investing - Part 1

Noah Kiedrowski - Contributor - Biotech


Dividend investing doesn't offer the most exciting means in which to invest these days when compared to stocks such as Netflix, Facebook or Amazon or sectors such as the biotechnology sector. Despite this lack of excitement, when considering the attributes this dividend space offers, such as decreased volatility, healthy yields, moderate risk exposure and a hedge against downside risk, it may be an ideal synergy for any long portfolio. This is especially true as the markets have been highly volatile due to weakness in China, an imminent fed rate hike and persistently low oil prices. Historically, companies that have an established track record of not only paying dividends but growing their dividends over the long-term have generally outperformed the their respective index with decreased volatility. I'll be utilizing The Vanguard High Dividend Yield ETF (ticker symbol: VYM) as a proxy for a high-quality cohort of large-cap centric dividend paying stocks. This type of dividend portfolio may prove to be a meaningful piece of an overall growth retirement strategy while providing a reasonable level of income and mitigating risk. The allocation within VYM offers a broad dividend paying portfolio and access to all sectors throughout the large-cap space without sacrificing diversification and in turn can generate sustained long-term growth and income while navigating volatile markets.

High-Level Overview

• The dividend space offers many long attributes: decreased volatility, healthy yields, moderate risk and a hedge against downside market swings.

• Dividend investing often gives rise to share buybacks, rendering an effective way to drive shareholder value via returning capital by repurchasing stock.

• VYM has outperformed the S&P 500 in past two down markets in 2008 and 2011 by 4.9% and 8.4%, respectively.

• VYM has more than doubled its dividend payouts over the past 5 years.

Mitigating risk and volatility with a high-quality cohort of dividend paying stocks

VYM is composed of high yielding dividend-paying large-cap companies and weighted by market capitalization. This domestically focused dividend paying ETF provides access to some of the biggest names across many different sectors that provide a healthy dividend yield, equity appreciation, diversification and decreased volatility. These domestically centric companies may provide additional protection when largely extraneous events are impacting U.S. markets. The top 10 holdings consist of high-quality companies: Exxon Mobile (XOM), Microsoft (MSFT), Johnson & Johnson (JNJ), Wells Fargo (WFC), General Electric (GE), Proctor & Gamble (PG), JPMorgan Chase (JPM), Pfizer (PFE), AT&T (T) and Verizon Communications (VZ). These top 10 holdings make up roughly 30% of the portfolio by weight and covers technology, energy, healthcare, industrials, financial and consumer defensive. The vast majority of companies that comprise the ETF portfolio are large-cap companies spanning value, blend and growth. Large value and blend categories account for roughly 75% of the portfolio holdings. Outside of these top 10 holdings, high-quality companies reside in market capitalization weighted proportions across a broad range sectors in its top 25 holdings (Figure 1).

Morningstar top 25 dividend paying holdings for VYM

Figure 1 - Morningstar top 25 dividend paying holdings for VYM

Decreased volatility and outperformance during bear markets

As a consequence of its high-quality dividend paying centric portfolio, the ETF has a majority of its holdings in more robust and financially stable companies that are the least impacted during economic turbulence domestically and abroad. The ETF specifically focuses on large-value companies within consumer defensive, health care and utilities. The weighted allocation within VYM that is dedicated to consumer defensive, health care and utilities is 14.7%, 12.4%, 7.7%, respectively. This defensive position equates to approximately 35% of the portfolio by weight (Figure 2). In terms of performance throughout bear markets, VYM has outperformed the S&P 500 in 2008 and 2011 by 4.9% and 8.4%, on an annualized basis respectively (Figure 2). These data exemplify the risk mitigation that is commonly intrinsic throughout large cohort of high-quality dividend paying stocks.

Morningstar sector breakdown of VYM

Figure 2 - Morningstar sector breakdown of VYM

Morningstar annual returns of VYM relative to the S&P 500 index

Figure 3 - Morningstar annual returns of VYM relative to the S&P 500 index

The potential combination of dividends and share buybacks

Many of the companies within the VYM portfolio not only offer a dividend but also reward shareholders via share buybacks. Share buybacks can serve as an effective way to drive shareholder value via returning capital by repurchasing its own stock. I'll discuss this dual synergy in greater detail in my part 2 of navigating volatile markets covering companies that engage in share buybacks. In brief, theoretically, repurchasing and retiring shares satisfies many pro-shareholder objectives:

1. Reducing the number of shares tilts the supply and demand curve thereby removing shares will decrease supply and in turn increase demand and drive the share price higher.

2. Earnings per share increase since earnings are now divided over fewer shares.

3. If share buybacks are coupled with a dividend, the dividend yield may increase as long as the aggregate quarterly payout amount remains unchanged and as a result the payout will be divided over fewer shares.

Microsoft and Wells Fargo are great examples of stocks within the ETF that reward shareholders with dividends and share buybacks. A number of constituents within the ETF help to drive share value with share buybacks while the aggregate holdings payout a dividend yield of 2.8% to augment total return. VYM provides a competitive yield to augment the growth component of the ETF, thus appears to be attractive as a potential candidate for any long portfolio.

Long track record in established dividends and dividend increases to augment total return

VYM boasts an impressive dividend yield, currently greater than 3% which rivals the majority of high-quality dividend paying stocks. This can be a very effective residual payout to augment total return when reinvesting the dividend distributions over time. Many companies within the ETF have a well-established track record in dividend payouts and dividend growth over time. Bristol-Myers Squibb Co (NYSE:BMY), AT&T (NYSE:T), Verizon (NYSE:VZ), Coca-Cola (NYSE:KO) and Phillip Morris (NYSE:PM) are just a few examples of companies within VYM that have regularly increased their dividend payout over the last 15 years. Taken together, this ETF portfolio is comprised of high-quality constituents that have a proven track record of consistent dividend payments and dividend growth. These two attributes can make a meaningful impact as part of any overall long portfolio strategy. Overall, the dividend payout per share of VYM on a quarterly basis has increased from $0.23 in March of 2010 to $0.56 in June of 2015 an increase of over 140% in dividend payouts (Figure 4).

Google Finance dividend distributions and cumulative returns over the previous 5 years

Figure 4 - Google Finance dividend distributions and cumulative returns over the previous 5 years


VYM makes a compelling case for the risk-adverse investor seeking long-term growth and income from a cohort high-quality dividend paying companies. VYM has an expense ratio of 0.10% and a dividend yield of greater than 3%, thus offering access to a high-quality ETF with a healthy rate of return and minimal risk at a very low cost. The mitigating risk aspect is exemplified during bear markets where VYM outperformed the S&P 500 4.9% and 8.4%, respectively in 2008 and 2014. VYM provides a compelling investment opportunity for investors seeking diversity across the large-cap space while mitigating risk and attaining a high yield and overall equity appreciation.

Noah Kiedrowski Contributor - Biotech

Disclosure: The author currently holds shares of Apple (once the largest holding in VYM) and Wells Fargo and is long both Apple and Wells Fargo. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses.