High dividend yields are often eye-catching and that’s particularly true when interest rates are low, as is the case today. However, dividend growth should always be a priority for income investors, and they can latch onto that theme with the FlexShares Quality Dividend Index Fund (QDF ).
QDF’s underlying benchmark targets management efficiency or quantitative evaluation of a firm’s deployment of capital and its financing decisions. By using a management efficiency screen, the index can screen out firms that aggressively pursue capital expenditures and additional financing, which typically lose flexibility in both advantageous and challenging partitions of the market cycle.
“Dividends are typically an indication that a business is established and financially healthy enough to return cash to shareholders,” writes Morningstar analyst Karen Wallace. “Dividends also force management to be focused on the long term and disciplined with their capital allocation decisions: After a company declares a dividend, it usually tries very hard to avoid cutting the payout, even during lean times. A dividend cut is a signal that a company’s earnings are weakening, which will lead many investors to dump the shares.”
QDF for Long-Term Dividend Investors
QDF emphasizes the quality factor, of which a company’s ability to generate free cash and dividend growth and stability are integral tenants. Another element that has been critical to QDF’s success is the emphasis on management efficiency and a company’s ability to generate cash.
Company stocks that issue high dividend yields can be masking their distressed books or may not be sustainable. Consequently, quality dividend ETFs try to limit the impact of these value traps by requiring a history of sustainable dividend growth.
“That’s not to say that investing in companies that pay higher dividends is a bad idea. (For purposes of this article, let’s define ‘dividend yielders’ as stocks with yields higher than 2%.),” notes Wallace. “But when investing in dividend yielders, your investment criteria should consider more than just the yield. In order to determine if a company can continue to pay out a high dividend yield, make sure you focus on stocks of companies that are financially healthy enough to sustain and even grow their dividend.”
QDF screens for management efficiency, profitability and cash flow. Each company has to show management efficiency, or firms that efficiently deploy capital and make smart financing decisions. Companies with wider profit margins are better positioned to grow and maintain dividends than those with slimmer margins. Additionally, firms that can meet debt obligations and day-to-day liquidity needs are better capable of maintaining dividends.
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