Table of Contents
Welcome to the first episode of my dividend ETF analysis series where I’ll take a deep dive into ETFs like SCHD.
I’ll be going over the ETF’s investment style, how the holdings are picked, expense ratios, how the ETF has performed and of course its dividend payouts and growth. In the long run, I’d like to compare and contrast the various ETFs I analyze and see which ones are worthy of my investment dollars.
The first to get the deep dive is Schwab’s U.S. Equity Dividend ETF. The ticker here is SCHD and this is one of the biggest dividend focused ETFs by AUM(assets under management).
SCHD Details
According to the Schwab, the fund’s goal is to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Dividend 100™ Index. I’ve added some high level details below. Naturally these show a point in time yield but you can always find updated data in this google spreadsheet. I’ll try to this up to date with all the ETFs analyzed in this series. We are off to a good start here. A passive strategy tracking an established index keeps the expense ratio very low. Anything under 0.1% is a good sign and shows that the ETF is very investor friendly.
There are no issues with volume or a large bid/ask spread as expected from something with this high an AUM. Only a few Vanguard funds are larger in this space showing investor trust in this ETF.
One negative is that the ETF is fairly new. It emerged after the 2008 recession so the data isn’t going to be very robust but it will at least cover some more recent downturns that have negatively impact dividend payers.
Based on the last 12 months of dividends, today’s yield is higher than the 5 year average. I’ll talk about that in more detail in the dividends section but that’s generally a good thing from a valuation perspective.
Now that we’ve covered the high level details, let’s take a look at how this ETF comes together.
Portfolio Construction
Before investing in an ETF, it’s always good to know the criteria that drive the investment choices.
SCHD follows a relatively passive strategy and tracks the Dow Jones U.S. Dividend 100 Index. This is a S&P Global index designed to measure the performance of high-yielding stocks with a record of consistency, selected for fundamental strength relative to their peers.
That sounds great but what does it mean?
In order to be included in the index, stocks must be part of the Dow Jones U.S. Broad Market Index(~2600 companies), must not be a REIT(for tax efficiency reasons) and pass the following three screens;
- A minimum of 10 consecutive years of dividend payments
- A minimum FMC(float-adjusted market capitalization) of $500M
- A minimum three-month ADVT(average daily value traded) of $2M.
The first screen is the hardest to pass and filters out a high percentage of companies. The other two screens are simply designed to make sure these companies have enough volume to be accessible by a large ETF.
All told, this filter takes the 2600 or so companies down to a few hundred.
These eligible securities are ranked based on each of the below four characteristics;
- Free cash flow to total debt : annual cash flow divided by total debt. Companies with no debt are ranked first.
- Return on equity : annual net income divided by shareholders equity.
- Annual dividend yield : annual dividend payout divided by share price.
- Five-year dividend growth rate.
The four rankings are equal weighted to create a composite score and the top 100 ranked based on that composite score are selected to the index. For any ties, the stock with the higher divided yield wins.
This seems like a reasonable approach as the above factors can define a good business. Companies with positive results in all four of these characteristics will yield a better composite score and thus have a better chance at being added to the index.
This scoring rubric is ran annually but a buffer is added to prevent too many changes as a stock only has to be in the top 200 upon annual review to stay within the index. Once a stock falls out of the top 200, stocks are added in based on their ranking until the stock count reaches 100.
I assume the buffer is there to keep it more passive, keep the expense ratio lower and minimize any potential tax implications.
Stocks are weighted based on their capped FMC. No stock can represent more than 4% of the index and no industry sector can represent more than 25% of the index. These are adjusted quarterly as needed. There is also another daily weight check to make sure no individual stocks make up too much of the index(sum of stocks making up more than 4.7% of the index cannot exceed 22%).
All of that seems a bit overly complex but the idea is to prevent an individual stock or two from becoming too overweight which could drive volatility.
Overall this leads to a portfolio that is full of familiar names but one that avoids companies that have only started paying dividends recently or have a very low yield.
While information technology is the biggest sector(as of 8/19/22), it’s represented by names like Cisco Systems(CSCO), IBM, Texas Instruments(TXN) and Broadcom(AVGO). Home Depot(HD), PepsiCo(PEP), Coca-Cola(KO), Merck(MRK), Amgen(AMGN) and Pfizer(PFE) round up the top 10.
These ten names make up 40.9% of the overall portfolio.
One criticism of this type of portfolio construction is that it avoids newer companies and or high growing stocks. Stocks with lower yields or a lack of long-term dividend history like Microsoft or Apple don’t make the cut.
However, this is by design as one has to remember that this is a yield dividend focused ETF and names like that don’t quite have the history or yield to support inclusion.
Now that we know the portfolio and its structure, let’s see see whether the portfolio construction drives good income results.
Dividend History and Growth
An income focused ETF like SCHD is defined not only by its performance but also by the income it produces. The goal here is to not only see consistent dividend yield but to see it grow as well.
We’ll jump straight into the charts with this part of the equation and see how SCHD fares on the dividend side. The first full year of payouts for this ETF was 2013 which is where the data starts.
Overall, this is a nice looking graph with an upward trajectory. Holders of SCHD have been rewarded with a nicely growing dividend without any interruptions. That last part is key as consistency is important in an ETF like this. Here’s another graph to visualize that growth on a year over year basis.
The overall dividend growth rate for SCHD since it’s first full year of dividends is 12.0% which is an solid rate of growth if you’re focused on income. It’s certainly beaten inflation during that time frame. In fact income has been boosted along with inflation in recent years despite some market turmoil and a pandemic. That’s an important part of the equation as you want an income focused ETF to be able to weather any economic downturns.
The beautiful thing about growing dividends is that your yield on cost(today’s yield/price you paid sometime in the past) keeps getting better.
Today’s SCHD’s price of $75.80 means a 3.2% yield based on the latest 12 month payouts but the yield on cost for earlier buyers is much better due to the growth in payouts they have seen.
For example, a buyer in 2013 could purchased a share around $30. At the time, based on 2013 payouts that was around a 3% yield but based on the most recent 12 months, that’s a yield on cost of 8.1%, a number that should continue to grow as dividends in the ETF grow.
It’s hard to know the right time to buy especially in volatile market like today, but a few years from now, today’s 3.2% yield should turn into a much higher yield on cost.
I mentioned a 5 year average earlier and will dive into more detail on that in the valuation section but in general, a 3.2% yield is a pretty solid one for this particular ETF as it has mostly hovered below a 3% yield. There have been better opportunities to buy but they don’t last very long.
The important thing is that the ETF continued growing through a year like 2020 and is on pace to continue growth in 2022 with the first two quarters being up 17.2% over the same period last year.
That lack of interruption in 2020 is key as even an S&P 500 fund like VOO saw its dividends drop by 4.8% that year. As another point of comparison, VOO’s dividend growth in this same time frame(2013-2021) was 7.2%. Pretty good but not quite the double digits we saw here.
Unfortunately, this ETF started in 2011 as it would have been interesting to see how it would have fared during the 2008 market rout. The index itself was created in 2011 so it was constructed of companies that paid dividends through the recession but that’s like picking the winners after the race and doesn’t guarantee future success.
However, it was good to see that we saw a 17.6% dividend increase during market conditions where the S&P 500 saw a 4.8% reduction which should give an investor at least some confidence in the strategy.
Now dividends are great but how about performance? It’s always important to look at overall returns when it comes to investing because dividends are just one part of the equation.
Sure, you might already be retired and just looking for income in which case dividend yield, growth and consistency matter most but even then overall return and appreciation of the underlying securities are still a good thing.
Performance
Since this is our first dividend ETF analysis, I’ll compare SCHD’s performance against the S&P 500 and a total stock market ETF. It’s not necessarily a fair comparison as the funds have different goals but should serve as a good starting point.
Future ETF analyses will include a comparison against SCHD and once we have a few done, it’ll be other dividend ETFs we’re comparing against.
Again, the data is constrained by the creation date of the ETF and will include January 2012 through July 2022. The portfolio returns reflect $10,000 invested at the beginning of the period with dividends re-invested.
Overall, the results are quite impressive. While the S&P 500 does edge out SCHD a tiny bit, SCHD is almost neck and neck with both ETFs.
One bonus here is that the worst year is much less bad with SCHD meaning you see slightly less volatility on a yearly basis. However, it is interesting to see that SCHD has the biggest max drawdown of the three. The ETF fell heavily between January 2020 and March 2020. However, it had a swift recovery and was back in positive territory by August.
It seems like the S&P 500 and the total stock market fell less during that period likely because of exposure to some of the bigger tech and growth names that fared much better during that period. The drawdown for the other two ETFs actually happened this year between January and June. It’s likely that an ETF like SCHD would fare a bit better during a prolonged recession than the others versus during a flash type crash like the one we saw in 2020. That’s not a guarantee but historically dividend focused names have fared better in such situations.
You can see the yearly performance of the three ETFs below.
On a yearly basis, SCHD has been a bit more stable than its brethren and has performed better in the market volatility we’ve seen this year. That’s largely due to the heavy losses some tech names have taken and again, SCHD doesn’t have too many of those and the ones it has are rather mature in their business model.
As I said, that lack of exposure to some growth names could be a bad thing but in years like this, it may turn out to be a blessing in disguise.
Overall, while the performance slightly lags something like the S&P 500, investors do get the benefit of less yearly volatility. On top of that, it’s not only gains that investors are after when it comes to dividend ETFs but income as well.
As I mentioned before, the dividend growth here eclipses the S&P 500 and that’s evidenced clearly below.
An investor in both SCHD and the S&P 500 ETF saw a 29% difference in income in 2013. SCHD’s annual payout was almost double by 2021 due to the focus on dividend growers.
Based on the ETF returns, I think investors would have been happy with the choices they’ve made by investing in either of these ETFs. It’s always good to see an income focused ETF keep pace with the market as it delivers income to investors who may depend on it. That’s the best of both worlds.
SCHD Overview, Valuation and Report Card
SCHD is a somewhat young ETF but its stellar performance and dividend growth have already made it a household name.
It’s low expense ratio means more of your money is working for you and the index it follows makes sure that any stragglers will eventually be kicked out to be replaced with a new name that warrants being in the top 100.
The lack of household names like Apple or Microsoft who some see as the future may be a concern for some but it hasn’t yet harmed the performance of this ETF one bit.
As of 8/22/22, from a valuation perspective, a P/E of 15.2 seems reasonable against the S&P 500 which sits north of 20.
SCHD sits only 8.1% off its 52 week high which is impressive given recent market dynamics but may also lead some to believe that better values exist elsewhere. That may be true but this is one ETF that rarely goes on sale as evidenced by its yield history below.
While there have been better opportunities to buy SCHD in the past(the spicy 4.3% yield during the max drawdown of 2020 looks appealing), the 3.2% yield based on the latest 12 months of payouts is better than the average yield an investor could have gotten in every year but one and better than the 5 year average yield of 2.9%.
It’s not the highest yield ETF if that’s what you’re seeking but the combination of performance, yield and growth seems like a winner.
Below you’ll find the very unscientific, made out of thin air report card that will adjust to ETF conditions as I do more of these reviews. However, for now, SCHD stands alone as a solid pick for me. I’ll be back to update it in the future but I believe it’s pretty accurate based on what I know about the dividend ETF space.
It’s a rare mix of good cost structure, growth and performance at a decent valuation. The lack of a long term tenure and no data through a big recession is a negative and its dividend yield isn’t the highest if that’s what you’re seeing.
Am I a buyer of SCHD at these levels? I am, it’s one of my regular buys and one of the better dividend focused ETFs out there in my mind. I’ll certainly keep an eye out for more attractive yields for bigger buys if the market corrects again but historically, this has been a solid bet at these levels.
Thanks for reading and please let me know if you enjoyed this type of post, if you’d like to see anything else in these type of post and if you have any specific dividend ETFs you’d like me to take a look at. This is a new series so I’m definitely looking for feedback as possible. Just hit that contact button and send me a note or leave a comment down below.
Disclosure : I am long SCHD and maybe be long other stocks discussed in this article. This is not investment advice and I am not a financial advisor. Please talk to a professional before investing as any investments come with risk of loss, sometimes permanent. This blog is for entertainment purposes only.
