This Dividend ETF Won’t Let a Stock In Unless It Passes 2 Strict Tests. Here’s Why That Matters.
Key Points
The iShares Core Dividend Growth ETF (NYSEMKT: DGRO) passively tracks an index made up of U.S. companies with a history of dividend growth. However, that index, the Morningstar U.S. Dividend Growth Index, won’t include a company unless it passes two strict tests:
- It must have increased its dividend for at least the past five straight years.
- It must have a positive earnings forecast and a payout ratio below 75%.
Additionally, the index excludes REITs and companies with a dividend yield in the top 10% of the dividends screened (after excluding REITs). Here’s why these two strict tests matter.
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Shifting the dividend focus from current to future income
Many of the largest and most popular dividend ETFs screen for dividend yield (e.g., SCHD and VYM). That’s because their primary focus is on generating current income for investors. The iShares Core Dividend Growth ETF has a different focus. It aims to deliver dividend growth. Stocks with a high dividend payout ratio (often those with high yields) are at a greater risk of dividend reduction and underperformance. That’s abundantly clear in the long-term data on companies by their dividend policies:
|
Dividend status |
Average annual total return |
|---|---|
|
Dividend Growers & Initiators |
10.22% |
|
Dividend Payers |
9.20% |
|
Equal-Weight S&P 500 Index |
7.74% |
|
No Change in Dividend Policy |
6.87% |
|
Dividend Cutters & Eliminators |
-0.96% |
|
Dividend Non-Payers |
4.21% |
Data source: Ned Davis Research and Hartford Funds. Note: Returns are based on S&P 500 members from 1973-2025.
The fund wants to ensure it tracks dividend growers, which is why it screens for companies with a history of growth and won’t let companies with high payout levels in since they’re at higher risk of maintaining their current payout, or worse, cutting or eliminating it. Those weaker companies would drag down the fund’s returns and income over the long term.
Putting the rules into practice
The five-year dividend growth rule is a useful framework because these companies have demonstrated a genuine commitment to dividend growth. They have proven that they aren’t just increasing their dividends when conditions allow, but have built a durable business that can deliver a sustainable, growing income stream to investors. It also screens out companies that don’t have a proven dividend growth track record, such as those that just started paying dividends or had paused growth and recently resumed.
For example, the fund’s top holding, Microsoft (NASDAQ: MSFT), has increased its dividend every year for more than two decades. That’s a proven record of dividend durability and growth.
Meanwhile, the 75% or less dividend payout rule helps ensure dividend stability. It shows that the company is generating enough cash to cover its current payment while retaining some earnings to fund growth. It also gives the company a cushion to continue growing its dividend if it hits a rough patch.
Many of its holdings are well below that benchmark. For example, Microsoft generated nearly $183 billion in cash from operations during its 2026 fiscal year. That easily covered the $26.4 billion it paid in dividends. Microsoft’s 14% payout ratio leaves it lots of room to grow.
Grow your dividend income with DGRO
DGRO tracks an index with two strict tests for dividend stocks that help ensure its holdings can sustain and grow their dividend payments. While it yields less than other dividend funds (less than 2% over the last 12 months), the dividend should grow over time. That growth should also enhance the fund’s total return, which has averaged 12.2% annualized since its inception in 2014.
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Matt DiLallo has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends Microsoft and Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
