DGRO ETF's Two Strict Dividend Tests Explained

How DGRO Selects Its Stocks

The iShares Core Dividend Growth ETF (DGRO) tracks the Morningstar U.S. Dividend Growth Index, which applies two strict criteria for stock inclusion. First, a company must have at least five consecutive years of dividend growth. Second, its dividend payout ratio must be 75% or less. The index also excludes real estate investment trusts (REITs) and companies with dividend yields in the top 10% of the screened universe.

These rules differ from many popular dividend ETFs, such as the Schwab U.S. Dividend Equity ETF (SCHD) and the Vanguard High Dividend Yield ETF (VYM), which focus primarily on current yield. DGRO's approach prioritizes dividend growth over immediate income, aiming to include companies with a track record of increasing payouts and the financial capacity to continue doing so.

Why These Tests Matter

The five-year dividend growth requirement helps ensure that a company has a genuine commitment to returning cash to shareholders. It filters out firms that have only recently initiated dividends or have paused growth, focusing instead on those with a durable business model that supports consistent increases. For example, Microsoft (MSFT), DGRO's top holding, has raised its dividend every year for over two decades.

The payout ratio limit of 75% is designed to promote dividend sustainability. A lower payout ratio indicates that a company retains enough earnings to fund operations and growth, while also providing a cushion to maintain or increase dividends during economic downturns. Microsoft's payout ratio is approximately 14%, based on its fiscal 2026 cash from operations of $183 billion and dividend payments of $26.4 billion, leaving ample room for future increases.

Historical data from Ned Davis Research and Hartford Funds (1973-2025) shows that companies with lower payout ratios have generally delivered better long-term returns and lower dividend cut risk compared to those with high payout ratios. By excluding high-yield, high-payout stocks, DGRO aims to avoid companies that may be forced to reduce or eliminate dividends, which could drag down overall performance.

DGRO's Performance and Characteristics

As of the latest data, DGRO has $44 billion in assets under management, an expense ratio of 0.08%, and a trailing 12-month dividend yield of 1.86%. Its top holdings include Microsoft (3.31%), Johnson & Johnson (3.15%), and JPMorgan Chase (3.12%). Since its inception in 2014, the fund has delivered an annualized total return of 12.2%.

While DGRO's yield is lower than some other dividend funds, the focus on dividend growth may lead to increasing income over time, which can enhance total returns. The fund's strict screening criteria are central to its strategy of investing in companies with sustainable and growing dividends.

What it means for income investors

For income-focused investors, DGRO offers a way to participate in dividend growth rather than just high current yield. The fund's rules aim to select companies with a history of increasing payouts and strong financial health, which may lead to growing income and potentially better long-term total returns. However, the lower initial yield means that investors seeking immediate high income might prefer other options.

Reporting based on: The Motley Fool. Figures verified against market data where available.