The goal of many investors is to generate passive income from their investment portfolios.
Indeed, the ultimate goal is often to have an income stream that (1) exceeds your normal living expenses and (2) grows over time. This allows you to live a fulfilling life using passive income while still leaving a nest egg for your loved ones.
Achieving this goal requires living below your means alongside a sound understanding of personal finance. It also requires a successful investing plan.
One excellent investment choice for people looking to generate ever-increasing passive income is the Dividend Aristocrats – stocks with 25+ years of consecutive dividend increases. In this article, we’ll explore the Dividend Aristocrats and explain how investors can easily achieve passive exposure to these stocks.
What are the Dividend Aristocrats?
The Dividend Aristocrats are a group of dividend-paying stocks that satisfy the following criteria:
- Membership in the S&P 500
- Consecutive dividend increases for 25+ years
- Meet certain size and liquidity requirements
The Dividend Aristocrats have a noticeably different composition when compared to the broader equity markets. While the S&P 500 is concentrated in technology stocks, the Dividend Aristocrats Index’s three largest sectors are consumer staples (22.8%), industrials (22.8%), and financials (12.3%). For comparison, the weight of each of these sectors in the S&P 500 is 7.2%, 9.5%, and 13.3%, respectively.
The Dividend Aristocrats Index is also much more concentrated than its larger index counterparts. While the S&P 500 contains 500 companies, there are currently just 57 Dividend Aristocrats. This speaks to the exclusivity inherent in the dividend history requirements of the Dividend Aristocrats.
The Performance of the Dividend Aristocrats
What immediately stands out about the Dividend Aristocrats is their remarkable performance over time. Over the last 19 years, the S&P 500 Dividend Aristocrats Index has outperformed the broader S&P 500 Index by 1% per year.
What’s especially impressive about this outperformance is that the Dividend Aristocrats’ performance has exceeded the performance of its benchmark with less risk - and despite being more concentrated. The S&P 500 Dividend Aristocrats Index has had an average price standard deviation of 11.53% over the last decade, while the S&P 500’s price standard deviation has been 12.59% during the same time period.
To adjust the performance of an investment based on its risk, finance professionals use the Sharpe Ratio. The combination of higher returns with less risk has led the Dividend Aristocrats to have a 10-year Sharpe Ratio that is noticeably higher than the S&P 500’s: 1.34, compared to 1.11.
Explaining the Outperformance of the Dividend Aristocrats
Identifying a group of stocks that has a history of outperformance is useless without understanding whether there is any economic intuition to explain this outperformance.
For example, one stock market phenomenon is called the “Super Bowl Indicator,” which states that if an NFC conference team wins the Super Bowl, then stocks should rise that year, while if an AFC conference team wins, then stocks should fall. This theory has an amazing 82% hit rate, yet we would never place any money on this bet because there is no economic intuition to justify it.
Turning back to the Dividend Aristocrats, let’s examine whether there are any common-sense reasons why these stocks might outperform the broader index. Fortunately, we believe there are three easy-to-understand reasons why the Dividend Aristocrats could very well continue to outperform in the future:
- In order to pay dividends, a firm must be generating real cash from its operations. This immediately excludes the two riskiest types of businesses from the Dividend Aristocrats: startup companies with no cash earnings, and companies going through a bankruptcy or some other sort of disruptive reorganization.
- When a company’s management team shares its success with shareholders through steadily rising dividend payments, it shows that the company is being operated with the shareholders’ best interests in mind. This behavior likely extends into other decision which are not as visible to outside minority investors.
- Distributing cash to shareholders means that less money is left within the corporation for reinvestment, which means the firm’s capital allocators must be especially thoughtful and selective when deciding which growth opportunities to fund. This means that the company likely doubles down on its best opportunities while ignoring subpar ones.
Given these logical explanations for outperformance, we believe the strong performance of the Dividend Aristocrats has a strong chance of continuing in the future.
How to Gain Passive Exposure to the Dividend Aristocrats
For investors looking to gain exposure to the Dividend Aristocrats, manually purchasing 57 unique companies and somehow managing to properly weight them seems like a daunting task. Fortunately, there is a much better way to invest in this group of dividend stocks.
ProShares has a passive ETF that invests in the S&P 500 Dividend Aristocrats Index. The ETF trades under the ticker NOBL, has a management expense ratio of 0.35%, and has net assets of $4.5 billion.
Investing in NOBL is an excellent way to gain exposure to the Dividend Aristocrats Index. If you’d like to learn more about the ETF, you can access its website and fact sheet here. You can also take a look at other high-dividend ETFs here and here, though note that some may not exclusively hold dividend aristocrats.
With the rise of AI and machine learning, you can even use those technologies to target Dividend Aristocrats for your portfolio.
This post introduced the Dividend Aristocrats – a group of S&P 500 stocks that meet certain minimum size and liquidity requirements and have 25+ years of consecutive dividend increases.
In many ways, these stocks are the best-of-the-best when it comes to dividend growth investing. In fact, they’ve outperformed the S&P 500 Index since inception while also boasting lower volatility.
Even though Dividend Aristocrats make up less than 10% of S&P 500 companies, it would be overwhelming and inefficient to buy all 57 individual stocks. Instead, investors can buy a single ETF that tracks this group. The ETF is managed by ProShares, trades under the ticker NOBL, and has a management expense ratio of 0.35%. For investors looking to gain passive exposure to high-quality dividend growth stocks, this ETF might fit the bill.
Disclaimer – This article is for informational purposes only. Investors should research all investment products independently or speak with their financial advisor before making any trades. Past performance is not indicative of future results.