ETFs
This Hugely Popular Dividend ETF Isn’t Just About Dividends
The Schwab US Dividend Equity ETF is one of the largest dividend ETFs, but there’s more to the portfolio than just yield.
Very often, dividend investors focus on dividend yield as their key screening metric. To some extent this makes sense, but it may miss important company-specific issues that might cause you to avoid an action. This is exactly why dividend investors looking for an exchange-traded fund (ETF) should look into Schwab US Dividend Stock ETF (SCHD 0.20%). Here’s what you need to know.
Everything for high returns
High yielding stocks often have high yields for a reason. Either the sectors they come from are known for high returns, like utilities and real estate investment trusts (REITs), or the companies have temporarily fallen on hard times, which is normal in cyclical sectors like energy or can be specific to a company. The fact is that buying stocks based solely on performance will often result in a portfolio concentrated in a small number of sectors and will often leave you with at least a few struggling stocks.
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This is not bad in itself, since performance is the main objective. And out-of-favor stocks often have a surge in value, if you will. buy stocks when they are cheap. There are a number of exchange traded funds from which you can choose in this regard, such as SPDR Portfolio S&P 500 High Dividend ETF (SPY 0.50%). This ETF is made up of the 80 best-performing stocks in the world. S&P500 Hint.
Even though the S&P 500 itself is made up of a hand-picked group of large, economically important companies, eliminating the top 80 performing companies from the list isn’t exactly wizard-level portfolio management. Real estate constitutes the largest segment of the portfolio with 26% of assets, followed by financial services with approximately 21% and utilities with approximately 18%. Together, these three sectors represent almost two-thirds of the portfolio.
Compared to what the SPDR Portfolio S&P 500 High Dividend ETF does, the Schwab US Dividend Equity ETF takes dividend investing to the next level.
The Schwab US Dividend Equity ETF is focused on yield and quality
For starters, the Schwab US Dividend Equity ETF excludes REITs, removing stocks that by their nature would their business structure, tend to have some of the highest returns. It also required stocks to have at least 10 years of annual dividend increases behind them, focusing on both consistent dividend payers and companies that provide shareholders with a growing income stream over time. There are also some rules regarding liquidity and market capitalization, but these are essentially fairly easy hurdles to clear. To be honest, nothing special is happening so far.
What comes next is unique. Schwab creates a composite score based on a number of key variables that attempt to highlight the quality of the company. Some of the key indicators of the composite score include cash flow to total debt, return on equity, dividend yield and five-year dividend growth rate. The ETF then ranks stocks from best to worst on its composite score, selecting the top 100 names, weighted by market cap, for inclusion in the Schwab US Dividend Equity ETF.
This approach combines yield and quality and leads to a slightly different portfolio composition. For starters, real estate is absent from the portfolio by design, but utilities are also a very small issue, at less than 1% of assets. The main sectors are financials, healthcare, consumer staples, industrials, energy and consumer discretionary. Although these sectors represent just over 80% of the total portfolio, the largest of them, financial services, only represents around 17% of the portfolio. That’s smaller than the third-largest sector in the SPDR Portfolio S&P 500 High Dividend ETF.
SPYD Total Return Price data by Y Charts
To be fair, the SPDR Portfolio S&P 500 High Dividend ETF yields 4.4% while the Schwab US Dividend Equity ETF yields less than 3.3%. However, the Schwab US Dividend Equity ETF is more diversified and the stocks it owns are likely to be of higher quality due to the selection techniques used. For the majority dividend-oriented investors If you’re trying to find a single ETF to buy, giving up a small yield here will probably make a lot of sense. And as the previous chart shows, the total return results, which assume dividend reinvestment, clearly favor the Schwab US Dividend Equity ETF’s approach.
Not All Dividend ETFs Are Created Equal
The big message here is that you can’t judge a dividend ETF on its yield alone – which is of course also true for stocks. You need to dig in and understand how the wallet is created. There are significant drawbacks when it comes to ETFs that consider yield only when constructing a portfolio, while ETFs like Schwab US Dividend Equity ETF attempt to create a more attractive portfolio by combining the yield with other fundamental data to select good companies that also have high yields. This will likely seem like a better long-term proposition to many investors.