As if the bear market isn’t bad enough, income investors must adapt to a world of slowing dividend growth. According to S&P Dow Jones Indices, third-quarter 2022 U.S. common dividend increases were $19.1 billion, down 0.9% from $19.3 billion in the previous quarter and down 14% from $22.2 billion in the same quarter a year ago.

Consensus projections call for similar decelerations of dividend growth next year. But you don’t have to settle for less.

Below, I highlight a simple and easy way to tap robust dividend growth. It’s an exchange-traded fund (ETF) that throws off a reliable stream of growing income, by picking the highest-quality dividend growth stocks for its portfolio.

First, let’s discuss the power of dividend growth and why under today’s uncertain investment conditions it’s more important than ever.

The tightening monetary spigot…

A key factor behind the downward trend of dividend growth is the U.S. Federal Reserve’s hawkishness with interest rates, in its efforts to combat inflation.

The nearly decade-long era of ultra-low interest rates had been beneficial for dividend-paying stocks. Not only could they often offer payouts greater than the yield on 10-year Treasuries, but they also racked up spectacular share price appreciation.

However, income-oriented investors currently face a changing backdrop. Rising bond yields are surpassing the payout levels of many dividend producers. To stay ahead of the curve, you need to focus on exceptional firms that have a long history of rising dividends, in any economic climate.

Fact is, rising rates tend to push up government bond yields, which makes dividend-paying stocks as a whole less attractive from a risk-to-reward standpoint. The benchmark 10-year Treasury currently surpasses 4.0%, whereas the S&P 500 Dividend Yield hovers at 1.82%, lower than the long-term average of 1.85% (see chart).

Consider yourself warned: Rising interest rates will likely clobber scores of overly leveraged, slow-growth companies with unsustainable high dividends.

But you can still find suitable high-dividend opportunities, if you apply the right criteria and know where to look. During this volatile bear market, one of the best defensive growth strategies is to choose companies with strong and rising dividends.

You don’t have to be an income investor to love dividend-paying stocks. Dividend-payers are time-proven vehicles for long-term wealth building, but they’re also safe harbors in turbulent seas because companies with robust and rising dividends by definition boast the strongest fundamentals.

If a company has the low debt and healthy cash flow required to throw off juicy dividends, it follows that the balance sheet is intrinsically sound enough to sustain the company through market corrections.

That’s why stocks with growing dividends are particularly appealing right now to both income and growth investors. What’s more, research shows that dividend growers outperform high-dividend yielders in the early stages of Federal Reserve tightening cycles.

Think of dividend growth investing as a total return-focused equity strategy with a defensive bias. But here’s the challenge: it’s one thing to find a growing yield; it’s another to find one that’s sustainable.

Planting seeds of wealth…

Here’s a safe dividend growth alternative with a proven track record: the WisdomTree U.S. Quality Dividend Growth Fund (DGRW). With net assets of $6.3 billion and a current dividend yield of 2.38%, this fund seeks to track the investment results of dividend-paying large-cap companies that also boast growth trajectories. The fund’s expense ratio is a low 0.28%.

The fund’s strategy emphasizes long-term profit growth over outsized dividend yields. Among the roughly 1,500 dividend-paying stocks in existence, WisdomTree U.S. Quality Dividend Growth Fund first screens for companies with a minimum market cap of $2 billion (although most are above $10 billion) and a dividend coverage ratio greater than 1.

From that pool of investable companies, DGRW pinpoints companies with healthy earnings expectations, return on assets and return on equity. DGRW also emphasizes businesses that consistently generate ample free cash flow and maintain conservative balance sheets. The management of these dividend-paying companies must be efficient, with capital allocation policies that generate both a high dividend payout ratio and solid growth.

The fund’s holdings represent the cream of blue-chip dividend payers, with about 300 stocks (mostly U.S. based) spread across diverse sectors. The top five holdings are Microsoft (NSDQ: MSFT); Apple (NSDQ: AAPL); Johnson & Johnson (NYSE: JNJ); Verizon (NYSE: VZ); Procter & Gamble (NYSE: PG); and Pfizer (NYSE: PFE), cumulatively accounting for 19.95% of assets.

DGRW’s top five fund sector weights are consumer defensive (20.79%); health care (19.63%); technology (18.62%); industrials (18.48%); and consumer cyclical (9.68%).

During the previous bull market, many investors did well by owning dividend stocks that got bid up because of low interest rates. However, amid rising interest rates, dividend paying stocks are increasingly at risk.

Chasing yields can lead to catastrophe. Buying quality dividend growers is a safer path to income as well as market outperformance. DGRW provides an inexpensive, low-maintenance way of pursuing this strategy.

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John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com

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