Dividend-paying stocks have been in focus in recent years, as many income seekers have turned away from low-yielding fixed income instruments and are looking to equity markets for an attractive level of income. With the rise of interest rates at the end of 2016, a continuing search for yield is expected. However, this search for yield will probably be guided by a focus on quality, and it likely will be against a backdrop of future rising rates.
Among different kinds of income-focused equity indices in the market, the Dow Jones U.S. Dividend 100 Index takes a unique approach. Not only does the index seek to track stocks with consistent dividend payouts, but it also applies quality assurance for the sustainability of yields. The index seeks to achieve “quality yields” by requiring stocks to have paid dividends for a minimum of 10 consecutive years, and by ranking stocks by a composite score calculated from the cash-flow-to-total-debt ratio, return on equity (ROE), dividend yield, and five-year dividend growth rate. A focus on dividend growth in an environment where market participants are concerned about rising rates is important. Typically, high-yield equity strategies are biased toward rate-sensitive sectors, which pay out high yields because of the leverage that they can take on (mainly because of mature business models, e.g., utilities). Such entities are exposed when rates rise. Selection based on dividend growth ensures that firms that have the ability to develop their business and increase their payouts are favored in the selection process. Such businesses often tend to be well-managed companies, both from a capital structure and from an operational perspective.