Key Points
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The S&P 500 is more concentrated than it looks: VOO’s top ten holdings are around 40% of its assets, as is its exposure to tech stocks.
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The last time the S&P 500 was this concentrated, it delivered lackluster returns over the next two decades.
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DGRO’s focus on dividend growth stocks and lower concentration could yield higher returns over the next 20 years.
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The S&P 500‘s (SNPINDEX: ^GSPC) 10 largest holdings currently comprise 40% of its value. This broad market index hasn’t been this concentrated since the 1960s. The next 20 years were a weak period for the S&P 500. That doesn’t bode well for the Vanguard S&P 500 ETF (NYSEMKT: VOO), which tracks the S&P 500.
That’s one factor driving my view that the iShares Core Dividend Growth ETF (NYSEMKT: DGRO) will outperform the Vanguard S&P 500 ETF over the next 20 years.
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The current concentration problem
Like the S&P 500 index that it tracks, the Vanguard S&P 500 ETF currently has a high concentration in the largest technology stocks. Its 10 largest holdings currently comprise nearly 40% of the fund, and technology companies also make up around 40% of its holdings. That’s due to the robust returns of large tech stocks, including the “Magnificent Seven,” over the past decade. They’ve delivered strong earnings growth and stock returns by capitalizing on megatrends like cloud computing, AI, and increased digitalization.
The concern is that the last time the S&P 500 was this concentrated, its returns suffered over the subsequent two decades. According to data from S&P Global, the S&P 500’s annualized returns from 1965 to 1975 were just over 1%. While the S&P 500’s annualized returns were stronger over the next decade at almost 11%, that still works out to around 6% annualized over those 20 years. While that historical performance doesn’t guarantee the next 20 years will see a repeat, the current concentration increases the risk of lower future returns for VOO.
A proven winning strategy with lower tech concentration
Whereas VOO tracks an index of the 500 largest publicly traded companies in the U.S., iShares Core Dividend Growth ETF tracks an index of U.S. companies with a history of dividend growth. It screens for stocks that have delivered at least five years of dividend growth. It also screens for positive earnings growth forecasts and a payout ratio below 75%, and excludes the top 10% by yield. That puts DGRO’s holdings in a solid position to continue growing their dividends.
That focus on dividend growers is noteworthy. Data from Ned Davis Research and Hartford Funds found that over the last 50 years, dividend growers have delivered a 10.2% annualized total return. That outperformed dividend non-payers (4.2%) and an equal-weighted S&P 500 index (7.7%). DGRO’s focus on dividend growers has paid off, with the fund delivering a 12% annualized return since its inception in 2014.
Meanwhile, DGRO has much less concentration. Its top 10 holdings account for 27% of its value, while tech companies account for only 18%. Its largest holding is oil giant ExxonMobil (3.3% weighting). Contrast that with VOO’s top holding, Nvidia, at 8.4%.
The potential to deliver market-beating returns
The S&P 500’s heavy concentration in top tech stocks could affect its returns over the coming decades as the economy evolves. Meanwhile, DGRO’s lower concentration and focus on dividend growers potentially position it to deliver strong returns over the next 10 years. That drives my view that DGRO will beat VOO over the next 20 years.
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Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia, S&P Global, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
