Dividend growth is one of the most powerful concepts in investing because it’s so compellingly simple.
A company paying a dividend that rises year by year generally can be considered financially strong – that’s one appeal. The other is that yearly dividend increases are one of the best and most accessible hedges against inflation.
Dividend growth resonates with investors to the extent that it’s often a key feature in the building of portfolios for exchange-traded funds holding dividend stocks. Example: the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ-T), which tracks an index built in part by screening for stocks that have increased their dividends annually for at least five straight years.
Unfortunately, dividend growth in the stocks held by a dividend ETF doesn’t always translate into dividend growth for investors holding the fund. If you look at the dollar amount of eligible dividends these funds pay, you’ll find they tend to move both up and down over the years.
Dividend ETF distributions are mainly eligible dividends, which are paid by corporations and qualify for the dividend tax credit in non-registered accounts. A small return of capital can also be a regular feature in monthly distributions.
ETF companies are generally great about showing you details about their distributions. On the iShares website, you’ll see that CDZ paid out $1.09 per unit in eligible dividends last year, up from 90 cents in 2021. Go further back and you’ll see both ups and downs. The payout of eligible dividends was 98 cents in 2020, $1.08 in 2019, $1.11 in 2018 and 91 cents in 2017.
The reason for the variability of dividends is that the stocks in the CDZ portfolio are rebalanced every January. Stocks can be deleted if their dividend payout is cut, or if the dividend remains flat for more than two consecutive years within a five-year period. CDZ may be built on dividend growers, but the actual mix of stocks produces varying amounts of cash dividends.
This is why dividend growth investors may not find what they’re looking for in dividend ETFs. With an individual dividend growth stock, you can look at the transaction history for your account and see the growing amount of dividends you’ve received over the years. With a dividend ETF, cash dividends can both rise and fall.