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The Vanguard High Dividend Yield ETF (VYM) is a great dividend ETF to consider. Although it offers an average dividend yield, it is one of the cheapest ETFs around with a low expense ratio and holds one of the most diverse portfolios of dividend stocks. Furthermore, its portfolio is dominated by some of the highest-quality dividend stocks which have been rewarding investors by growing payouts for several years and are well-positioned to continue going this way in the future.
Image courtesy of Pixabay
This hasn’t been a great year for some income-seeking investors as treasury yields have fallen this year on expectations of a rate cut from the Federal Reserve. In fact, the 10-year treasury yield dropped to its two-year lows of under 2% in July before recovering to 2.09% at the time of this writing. The current yield is still well below the recent peak of more than 3.2% seen in November. J.P. Morgan Chase and Wells Fargo have modeled one to three rate cuts from the Fed this year in their earnings forecasts.
The low rates have increased the appeal of high yielding dividend stocks for income-seeking investors. Growth investors may also want to get behind the dividend stocks during these times since a declining interest rate environment can push the prices of high-yielding stocks higher. This might be a great time to invest in high-quality dividend stocks that offer sustainable payouts. Those investors who don’t have time to construct a dividend portfolio should consider a dividend-focused ETF which can give them exposure to several great dividend stocks at a low price, such as the Vanguard High Dividend Yield ETF, or VYM.
VYM is one of the largest dividend ETFs around, with $25.6 billion of assets under management. This makes it the second-largest dividend ETF, behind only Vanguard Dividend Appreciation ETF (VIG) which manages $36.8 billion of funds but ahead of the well-known SPDR S&P Dividend ETF (SDY) and the iShares Select Dividend ETF (DVY) which manage $18.9 billion and $17.6 billion of assets respectively. Additionally, VYM is highly liquid with an average daily trading volume of almost 900,000 shares or $79 million.
VYM follows the FTSE High Dividend Yield Index which tracks all those companies (ex. REITs) which offer an above-average dividend yield. The ETF selects a variety of more than 400 dividend stocks ranging from the largest US vertically integrated oil producer Exxon Mobil (XOM) valued at $321 billion to the racing facilities owner Speedway Motorsports (TRK) which has market a cap of $758 million. It then ranks these stocks based on market cap, meaning the biggest companies get the top positions and the largest share of assets in VYM’s portfolio while the small companies sit at the bottom.
VYM currently offers a decent 12-month dividend yield of 3.03% which is slightly higher than the average of 3% offered by dividend-focused ETFs. VYM’s yield is much higher than the 10-year treasury yield of 2.09%, the S&P-500 average of 1.93%, and the 1.7%-2% yields offered by a number of dividend ETFs such as the Vanguard Dividend Appreciation ETF and the SPDR S&P Dividend ETF. There are, however, other leading dividend ETFs (with >$1Bn of AUM) which come with a higher yield than VYM, such as the iShares Select Dividend ETF which yields 3.33% or the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) which yields 4%.
That being said, VYM is one of the cheapest funds among high-yielding dividend ETFs. It comes with an expense ratio of just 0.06% which means that the fund charges $6 per year on every $10,000 of investment. By comparison, those dividend ETFs which promise an above-average yield of more than 3% typically come with a higher expense ratio. Invesco S&P 500 High Dividend Low Volatility ETF and iShares Select Dividend ETF, for instance, charge much higher expense ratios of 0.30% and 0.39% respectively. There are some dividend ETFs which also feature an expense ratio of 0.06% but they usually offer a below-average dividend yield of less than 3%. The Vanguard Dividend Appreciation ETF also has an expense ratio of 0.06% but it currently yields just 1.74%. VYM, therefore, has one of the best combinations of yield and expense ratio.
What I also like about VYM is that it has a highly diverse portfolio which gives investors exposure to 419 dividend-paying stocks. By comparison, a majority of other dividend ETFs usually have between 50 and 200 companies in their portfolios. Through VYM, investors can gain access to not only the dividend aristocrats, or those S&P-500 companies like Johnson & Johnson (JNJ) which have a solid track record of consistently increasing dividends for more than 25 years, but also a number of mid-to-small-cap dividend stocks like Office Depot (ODP) which usually get ignored by other dividend ETFs.
Image: VYM – Vanguard High Dividend Yield ETF, Vanguard.
VYM is also not heavily exposed to any single company or an individual sector. Its top holding is Johnson & Johnson which gets just 3.6% of the fund’s net assets. The top-10 holdings account for less than 27% of the fund’s assets. Similarly, its top sector is financials which represents just 18.4% of the fund’s assets which is lower than some other dividend ETFs which allocate 20% or more assets to the top sector. This diversification insulates the ETF from the risks related to the plunge in prices of individual stocks or sector-wide sell-offs.
I also like the fact that VYM is overweight on some of the highest-quality dividend-paying stocks in the industry. As indicated earlier, the ETF ranks the stocks based on market-cap instead of yield which is a good thing since most of the well-established dividend-paying companies are typically categorized as large-cap.
Six of the ETF’s top ten holdings – namely Johnson & Johnson, Exxon Mobil, Procter & Gamble (PG), AT&T Inc (T), Chevron Corp. (CVX), and Verizon Communications (VZ) – have a rich history of growing dividends for at least 10 consecutive years (the first five are dividend aristocrats). Stocks like these generate reliable levels of cash flows and profits even as they go through various business cycles and face all sorts of business issues, including changes in consumer trends and political pressures. Their solid levels of cash flows and earnings have allowed them to return tons of cash to shareholders year in and year out. Their performance is a testament to their rock-solid business model, which is underpinned by sustainable competitive advantages which enable the company to hold out against domestic and global recessions.
Some of other VYM’s top holdings may not have consistently grown dividends for a decade but they still offer safe and reliable dividends. VYM’s tenth-largest holding Merck & Co. (MRK), for instance, is no Johnson & Johnson which has increased its dividend for 56 consecutive years. But Merck has been growing shareholder payouts for the last several years and is well-positioned to significantly grow earnings and cash flows in the future which will drive further dividend hikes. The company’s powerful immunotherapy drug Keytruda generated more than $7 billion of sales last year and is on track to post significant growth in 2019 as it gets FDA’s approvals for the treatment of different types of cancers. The company also has other promising cancer drugs, such as Lenvima and Lynparza, which can drive its future growth.
In short, VYM offers an average dividend yield. However, I believe a combination of a low expense ratio, diversified portfolio, and a tilt towards large-cap and high-quality dividend stocks make VYM a great ETF. The fund’s shares have climbed 13% this year and I expect it to continue rising in the near future, particularly in 2019 if the Fed cuts interest rates and investors flock to high-quality dividend stocks. Although VYM is currently reasonably priced at 16.9x earnings, lower than the peer median of around 18x, as per my calculations, it is currently hovering near 52-week highs of $89.47. I suggest investors should closely follow this ETF and consider buying on weakness.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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