MSFT - SCHD Could Be The Best Equity Dividend ETF For 2023

Summary

• SCHD has outperformed the market over the previous 5 years and offers a dividend yield that is double traditional index funds.
• SCHD doesn't sacrifice upside potential for dividend income, so this hybrid ETF should do well if the market turns in 2023.
• SCHD has grown its dividend for 10 consecutive years and investors should get another increase in 2023 as all of its holdings are considered dividend growth companies.

While 2022 was a perplexing year for investors as the Fed went gangbusters on the fed funds rate, and the S&P 500 finished down -19.95%, there was no shortage of yield. Throughout 2022, the 2-year treasury note went from generating yields of less than 1% to 4.43%. Investment vehicles that utilize options to amplify their dividends gained increased popularity, and as investments lost value, their dividend yields increased. After being in a yield-starved environment where a large cap generating a 3% yield was enticing, there is no shortage of attractive income-producing investments for investors. Now that there are no-risk options to generate yield, making an equity investment is much more challenging. If an investor can tie up capital for 2 years through a U.S. Treasury note and generate 4.43% risk-free, why would they take on equity risk tied to a sub 4.43% yield? Nobody knows what 2023 will bring, and while the S&P 500 has had 26 years in the red since 1928 (28.57%) it's very uncommon for back-to-back negative years to occur. Since 1928, the S&P 500 declining YoY sequentially has only occurred 8 times (8.79%), and based on historical occurrences, inflation declining, and the possibility of a Fed pivot in 2023, there is a modest chance that the S&P 500 will finish in positive territory for 2023. If the market appreciates, hybrid ETFs that don't cap upside appreciation through utilizing covered calls and offer a modest dividend yield could become very attractive again. The Schwab U.S. Dividend Equity ETF ( SCHD ) could be the best equity-focused ETF to benefit from a rising market while generating a respectable dividend yield.

2022 is in the books and SCHD has generated more capital gains than its peers and the S&P 500 over the past 5-years

High-yield investment products became increasingly popular in 2022 as they provided substantial income in a down market. While the SPDR S&P 500 Trust ( SPY ) declined by -19.95% in 2022, the Global X S&P 500 Covered Call ETF ( XYLD ) declined -22.42%, but it had generated a 13.40% yield over the TTM, offsetting a significant portion of 2022's losses. Some investors have zero interest in covered call ETFs as they don't want the upside potential capped, especially coming off a down year. Many investment products cater to specific investment needs, and I believe SCHD is the best hybrid equity ETF. Before getting into the analysis, in addition to disclosing my positions at the end of the article, I want to disclose that I am a shareholder of SCHD, the SPDR Portfolio S&P 500 High Dividend ETF ( SPYD ), and the Vanguard High Dividend Yield ETF ( VYM ).

Below are the different funds that I compare SCHD against, as these are its peer group from the other major firms, in addition to an S&P index fund and a total market fund.

• SPDR Portfolio S&P 500 High Dividend ETF
• Invesco S&P 500 High Dividend Low Volatility Portfolio ( SPHD )
• iShares Core High Dividend ETF ( HDV )
• iShares Select Dividend ETF ( DVY )
• Vanguard High Dividend Yield ETF ( VYM )
• iShares Core Dividend Growth ETF ( DGRO )

For an S&P 500 index fund and a Total Market Fund, I have selected:

• SPDR S&P 500 Trust
• Vanguard Total Stock Market ETF ( VTI )

Many investors love traditional index funds, but dislike the lower-than-average yields. SPY, for instance, pays a dividend of $6.32, which is a 1.65% yield. This has to be expected, as Apple ( AAPL ) represents 5.93% of the fund and has a yield of 0.77%, and Microsoft ( MSFT ) represents 5.50% of SPY and yields 1.13%. There are also companies such as Amazon ( AMZN ), representing 2.28%, and Alphabet (GOOG) ( GOOGL ), representing 1.62% of SPY that don't pay a dividend.

While the market reached new highs last winter, the gains absolutely eroded in 2022. In addition to most of 2021's gains evaporating, SPY generated a low yield that was either taken as cash or reinvested back into the ETF. The average annualized return of the S&P 500 since its inception through 2021 was 11.82%, and when 2022's -19.68% loss is factored in, the annualized average return has been 11.47%.

Looking at all 9 ETFs together, over the previous 5 years, they have appreciated between 3.06% and 45.13%. SPY and VTI, which are the baselines, appreciated 39.87% and 36.20%. SPHD, SPYD, DVY, and VYM underperformed the market benchmarks, while there were two equity-focused dividend ETFs that exceeded the amount of appreciation that SPY or VTI generated. DGRO has appreciated by 40.92% over the past 5-years, while SCHD has been the top-performing ETF in the group, appreciating 45.13%.

What is more interesting to me is looking at what these ETFs did in just the calendar year of 2022. SPY declined by -19.95%, and VTI declined -21.31%, while the dividend-focused ETFs had a range of appreciating by 3.01% and declining by -10.15%. In a down year for the market, only DGRO fell by double digits on a percentage basis, while the other dividend-focused ETFs declined by single digits or actually appreciated.

After looking at these ETFs over a 5-year period and a 1-year period, SCHD looks more enticing than every ETF in the group in my opinion. SCHD did a fantastic job of mitigating losses in 2022 as it declined by -6.52% compared to -19.95% for SPY. Looking at the 5-year period, SCHD was able to capitalize on appreciation better than any ETF and outperformed SPY by 5.26%. None of the upside appreciation was capped, and most of the losses were mitigated. This is prior to taking the dividends into account.

SCHD has established a strong dividend track record that can be enticing to most investors

SCHD has some phenomenal statistics behind its dividend. While we are living in a high-yield environment, SCHD offers a dividend yield of 3.38%, which stands out considering SPY offers a 1.65% yield and SCHD has outperformed SPY on an appreciation basis over the past 5-years. SCHD has become a hybrid that can offer both modest yield and capital appreciation while mitigating downside pressure.

SCHD has paid a $2.56 dividend over the TTM, which has grown annually for 10 consecutive years. Over the past 5 years, SCHD has a 5-year dividend growth rate of 13.74%. Since SCHD's 1st full year of paying dividends, its annual dividend has grown by 216.05%, increasing from $0.81 to $2.56. In the previous 5-years. SCHD's dividend is supported by holdings within SCHD that must have a minimum of ten consecutive years of dividend payments and a minimum float-adjusted market capitalization of $500 million. The stocks within SCHD are evaluated by being the highest dividend-yielding stocks in the Dow Jones, their cash flow to total debt, return on equity, dividend yield, and 5-year dividend growth rate.

Why I am bullish on SCHD going into 2023

In an economic environment where rates have risen drastically, the cheap money has disappeared. There is no telling when a Fed pivot will occur or what a pivot would actually look like in the future. SCHD is made up of high-quality companies that aren't as impacted due to rising rates as growth companies are. When I look through SCHD's top 10 holdings , I believe several of the names are undervalued, including Verizon ( VZ ), Cisco Systems ( CSCO ), and International Business Machines ( IBM ). If the market rallies in 2023, SCHD should do well, as its components should lead the market higher. From a dividend perspective, all its components have an established history of increasing their dividends annually, which should correlate to an 11th dividend increase throughout 2023 for SCHD. If the market turns, SCHD doesn't have its upside capped, and it should appreciate more than the other equity dividend ETFs in its peer group while generating modest income throughout the year. If the market declines further in 2023, SCHD should be positioned to mitigate the downside once again.

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