Quality Dividends Matter

Many companies pay dividends to their shareholders of varying amounts at different intervals. Some companies pay regular monthly, quarterly, or annual dividends while others might pay dividends during boom times, but cut dividends during bust times to preserve cash. Even dividends from different companies of the same amount might differ in quality; one company may pay out dividends using debt while the other pays out dividends using a stable cash flow. For all of these reasons and more, we believe it is important to invest in high-quality dividends as characterized by three factors: the quality of the company, the investor-friendliness of the dividend policy, and the company’s valuation.

A high-quality company with respect to dividends is one that has stable business, high free cash flow, a clean balance sheet, proven management, barriers to entry, and disciplined capital reinvestment. These types of companies tend to be more established, relatively large in size and market capitalization, and fall in the utilities, telecom, energy, and healthcare sectors. Disciplined capital reinvestment is essential for being able to provide shareholders with valuable dividends that may grow over time. Reinvesting too much or toward risky growth initiatives puts a shareholder’s dividends at risk. Not reinvesting enough compromises the modest growth potential that allows a company to pay dividends in the first place.

Companies with secular, as opposed to cyclical, growth also tend to provide investors with quality dividends because they exhibit lower volatility. Stable revenue streams, high cash flow, and disciplined capital reinvestment also contribute to a company’s relative market volatility. Well-established healthcare companies, for example, are typically good bets for dividend investing, especially as an aging baby boomer population demands more medical services.

While secular growth and high cash flow are positive characteristics of a quality dividend, more growth is not necessarily always better. Dividend investors typically look for long-term expected growth between 5% and 15% because anything higher than 15% might lead to disappointing earnings (1). Quality dividends within these growth parameters provide what those interested in dividends look for: the probability of a payout over the potential for higher capital gains in the future.

In addition to company quality, dividend quality is determined by how investor-friendly the dividend policy is. Characteristics of investor-friendly policies include attractive current yields, transparency, tax-efficiency, and a company’s willingness and ability to increase the dividends per share over time. The latter is also a reflection of the company’s overall health, which adds to its attraction as a dividend investment opportunity.

Finally, company valuation is essential for determining dividend quality. The dividend payout ratio is a proportion of a company’s earnings, but it is also correlated to the company’s stock price. Companies that meet the above criteria and are undervalued in the market are able to pay consistent and significant dividends that outperform alternatives. Due to the complexity of factors at play, we believe it takes an experienced asset management team to assess quality dividends.

The fund management team for the TrueShares DIVZ ETF focuses on a concentrated group of 25-35 well-run companies with market capitalizations over $8 billion. This actively managed dividend fund seeks to provide capital appreciation by investing in undervalued companies with sustainable growth and an established track record of dividend payments. These companies meet the characteristics for consistent, quality dividends including stability, high cash flow, reliable management, disciplined reinvestment, and lower volatility.