DGRW: The Dividend Growth Tilt Your Value Portfolio May Need

Dividend-focused ETFs were outperformers in 2022 thanks to their value tilt and underweighting of technology stocks. Non-dividend-paying stocks were among the worst performers last year, while sectors that outperformed such as healthcare and consumer staples are littered with dividend-paying companies. One of the better-performing funds last year was WisdomTree U.S. Quality Dividend Growth (NASDAQ:DGRW).

DGRW's performance was impressive because the fund has substantial technology exposure. Almost 27 percent of the fund is in technology. A huge chunk of that exposure is also in two stocks - Microsoft (MSFT) and Apple (AAPL) - that saw substantial losses in 2022. They still combine for more than 11 percent of the portfolio and are the fund's top two holdings. Altogether, the fund has four tech holdings in its top 10. Three of them are down about 20 percent in the past year, while one is flat. Compared with growth and tech indexes, these are impressive results, but they were still an anchor on performance.

Away from technology, top holdings such as Merck (MRK), Philip Morris International (PM) and Johnson & Johnson (JNJ) delivered gains over the past year. Merck was well ahead of the pack with an increase of nearly 50 percent last year.

The strength of dividend funds last year, including ones more focused on growth and capital appreciation such as DGRW, reinforces the case for dividend stocks in a portfolio. While these funds often underperform during a bull market, in the long run, they deliver more consistent returns with lower volatility.

Although DGRW is not specifically an income fund, it has delivered solid dividend growth in its history. Aside from about a year of falling dividends in 2020, dividends historically have risen on an annualized basis. The monthly paying fund delivered $1.30 per share in dividends through December 2022, up 10.8 percent from a year earlier. The yield isn't high at 1.87 percent, but investors with a time horizon longer than 5 years or, better, 10 years will see substantial income growth over the longer term.

Index Strategy

DGRW tracks the WisdomTree U.S. Quality Dividend Growth Index. It has an expense ratio of 0.28 percent. DGRW earned a 5-Star Gold rating from Morningstar.

DGRW is not a dividend fund in the sense of being designed for higher income. Instead, it uses dividends as a tool for finding companies with better growth prospects and lower valuations. DGRW focuses on profitability criteria such as return on assets and return on equity. More profitable companies will see better stock performance, for a greater total return. It also considers dividend growth.

DGRW weights companies based on their cash dividends; thus, Apple and Microsoft are top holdings because they pay tens of billions of dollars in dividends each year.

The portfolio has changed substantially over time because companies with faster-growing dividends will move up in DGRW faster than their market capitalization growth might otherwise warrant. At times, the fund has been heavily invested in biotechnology and consumer discretionary. As with other indexes that use complex financial criteria, investors cannot bank on the fund's sector exposure remaining constant year to year. Instead, they are betting that the fund's selection process will deliver higher returns over time.

Portfolio

DGRW has an average market capitalization of $148 billion. This is below the Large Blend category average of $239 billion. Technology, consumer staples, industrials, healthcare, financials and consumer discretionary have 95 percent of the fund's assets, with the largest being tech at 27 percent of assets and the smallest consumer discretionary at 11 percent. The fund has small exposure in materials and real estate and less than 1 percent in energy, utilities and communication services.

The top 10 largest holdings are Microsoft 6.64 percent, Apple 4.57 percent, Johnson & Johnson 3.93 percent, Procter & Gamble (PG) 2.98 percent, The Home Depot (HD) 2.75 percent, Merck 2.59 percent, Coca-Cola (KO) 2.52 percent, Broadcom (AVGO) 2.50 percent, Philip Morris International 2.42 percent and Cisco (CSCO) 2.12 percent.

DGRW has a beta of 0.86 and a standard deviation of 18.97, both lower than the category's 0.98 and 21.18, respectively, making it a lower-volatility option.

Performance

DGRW declined 6.34 percent in 2022. Over the past 3- and 5-year periods, it gained an annualized 10.75 percent and 9.98 percent, respectively.

Since inception, DGRW has performed similarly to the S&P 500 Index except during the 2020-2021 bubble in growth stocks. Then DGRW underperformed, as did most value stocks. Since then, DGRW has roared back. Since inception, DGRW is now beating the S&P 500 Index by almost 20 percentage points. DGRW has been widening its lead on the S&P 500 in recent months. It has outperformed the S&P 500 Index by 4 percentage points since October.

Outlook

DGRW is a growth fund, but its focus is on dividend growth. This separates it from the typical growth fund that has hefty exposure in non-dividend-paying stocks, though it does usually mean DGRW behaves more like a growth fund relative to other dividend funds. This is a bonus for investors who make heavy use of a dividend strategy and end up with a heavy value tilt in their portfolio.

DGRW has historically performed better than the average dividend fund during bull markets but worse during bear markets and corrections, when investors typically prefer holding consumer staples, utilities and healthcare stocks. For longer-term investors, this makes DGRW an attractive buy during market downturns and corrections because they can accumulate shares during a period of weakness.

Another benefit of DGRW is that it has a wider universe of potential stocks than many dividend funds. Apple was added to the fund shortly after it started paying a dividend, but other funds require as much as 10 years of rising dividend payments for inclusion. This criterion makes a quality portfolio but it does eliminate some good companies. Thanks to its different selection criteria, DGRW can help a dividend-focused portfolio achieve a more balanced portfolio with a better growth profile.

DGRW can be used as a core holding within a diversified portfolio by both dividend investors and aggressive investors who may not be using a dividend strategy in their portfolio design.