Reality Shares rolled out its still-tiny ETFs this year to capitalize on the dividend wave. The ETF company says the key to its approach versus the standard dividend investing model is use of multiple measures, including cash flow, Altman Z-scores (a corporate bankruptcy risk measure) and dividend history, to come up with its predictions. Most dividend formulas rely on historical dividend trends alone.
Reality Shares Divcon Dividend Leader (LEAD) focuses on S&P 500 stocks rated at the top of the firm's proprietary scale of how likely a dividend boost is, with top holdings including Equifax, Texas Instruments and Tyson Foods. Reality Shares Dividend Defender (DFND) is 75 percent long on stocks that managers think will raise dividends, usually sporting the same top-rated stocks as Dividend Leader, and 25 percent short on companies the calculations show are likeliest to cut dividends. Reality Shares Dividend Guard (GARD) is also allowed to short stocks under its charter, but only does so when three or more sectors in the S&P 500 are flashing negative, Ervin said. Right now that fund is 100 percent long, he said.
For the latter two, the theory is that companies that grow dividends consistently tend to have returns that outpace the market while companies that cut dividends tend to lag. On the other hand, predicting stocks likely to increase dividend yields is not the same as finding stocks with the highest dividend payouts — LEAD currently has an annual yield of 1.69 percent, which is below the yield of the largest core dividend ETFs at 1.69 percent annualized (it has made only two dividend payments thus far).
"We shall see if they can identify companies that cut a dividend. It remains quite rare, and high-yielding stocks can remain high yielders for quite some time," said Todd Rosenbluth, director of mutual fund and ETF research at S&P Global Market Intelligence.
DFND and GARD have not paid any distributions to date. Quarterly distributions are authorized, though not required, for these ETFs. In the case of DFND, its short position in stocks means that the ETF can owe more in dividends in any given quarter than it is generating in dividend payouts from its long positions. It is required to pay the dividends on stocks it has shorted to its securities broker. GARD, which has been 100 percent long since May, could pay out its first dividend in the third quarter, according to Kian Salehizadeh, Reality Shares senior analyst.