TXN - SCHD: Dividend ETF That Delivers Consistent Dividend Growth

2023-12-23 01:00:32 ET

Summary

• SCHD is a dividend-focused ETF that has provided substantial dividend growth with a 5-year dividend CAGR of 13%.
• It has outperformed similar funds over the past 5 years and has a low expense ratio of 0.06%.
• The fund has a conservative approach and a lower exposure to the technology sector, which may limit its potential for capitalizing on tech industry growth.

Overview

As someone who really values the cash flow that dividends provide, I've spent countless hours trying to craft the perfect portfolio that delivers high total return as well as sizeable dividend growth. SCHD is one of those funds that have historically provided both. While it isn't perfect, I do believe it can be a solid starting point for newer dividend focused investors that are hesitant at their ability to analyze individual stocks. I also believe it can be an anchor position for the more seasoned investors because of the total return it can provide.

The Schwab U.S. Dividend Equity ETF ( SCHD ) is designed to closely mirror the performance of the Dow Jones U.S. Dividend 100 Index. SCHD is usually known as a straightforward and cost-effective investment option because of it's potential tax efficiency. This makes it a popular choice amongst investors that value getting some distributions from their portfolio.

The fund can usually play a versatile role within a portfolio. Meaning, it can serve either as a core holding or as an asset to enhance diversification. Historical performance has shown us that either approach usually works out pretty well when compared against similar funds. SCHD focuses on tracking an index that emphasizes the quality and sustainability of dividends.

Why SCHD Is So Popular

SCHD has become the pillar in certain dividend investing communities. Take a look over on Reddit's dividend community to see how dedicated people are to building up their SCHD position. Your reasonings against SCHD will fall upon deaf ears because the fund has been hailed the hero of dividend ETFs. This is easy to understand when you look at the total return over the years compared to the competitors.

Some similar funds we will be comparing SCHD against are:

• Vanguard High Dividend ETF ( VYM )
• SPDR S&P 500 High Dividend ETF ( SPYD )
• iShares Core Dividend Growth ETF ( DGRO )
• Vanguard Dividend Appreciation ETF ( VIG )

As we can see, SCHD has a higher total return over the last 5 year period. This kind of total return contributes to the popularity of the fund. Another reason that SCHD is so popular within the dividend investing community, is that it also happens to be very cost efficient as the total expense ratio comes in very low at 0.06%. This means the cost of $10,000 invested would only be $60 worth of fees.

Lastly, what makes SCHD so popular is the stellar dividend growth that seems to happen regardless of market condition. For reference, the dividend CAGR (compounded annual growth rate) over the last 5-year period is 13.05%. Ask yourself, has your job given you a 13% raise for the last 5 years in a row? This is the consistent dividend growth that makes SCHD popular and makes it a wise choice for investors looking to nail some stable income.

Therefore, this fund is an attractive candidate for several kinds of investors. This is attractive for the investor that values dividend growth. This fund is equally as attractive for the investor that aims to have a total return that closely matches the S&P ( SPY ) as well. Either use strategy has been proven effective over time.

Holdings & Strategy

SCHD has a total of 104 holdings and a portfolio turnover rate of 26.6%. The portfolio turnover rate is a way that measures the frequency in which assets within a portfolio are bought or sold. It provides insight into the level of activity and trading strategy employed by the fund manager. A high turnover rate suggests more active management. Conversely, a low turnover rate is indicative of a more passive or buy-and-hold strategy. Having a low or high turnover rate isn't inherently a bad thing. It's just something to keep in mind.

With the case of SCHD, this is a more passive form of management. The top holdings by percentage of assets are as follow:

1. Broadcom ( AVGO ) - 4.49%
2. Home Depot ( HD ) - 4.26%
3. AbbVie ( ABBV ) - 4.17%
4. Texas Instruments ( TXN ) - 4.10%
5. Chevron Corp ( CVX ) - 3.97%
6. Merck & Co ( MRK ) - 3.96%
7. Cisco Systems ( CSCO ) - 3.94%
8. Amgen ( AMGN ) - 3.93%
9. PepsiCo ( PEP ) - 3.77%
10. Coca-Cola ( KO ) - 3.76%

Looking at the top ten holdings, you probably wouldn't expect the heaviest weight of the portfolio to be industrials. SCHD operates by following a set of specific criteria for the inclusion of stocks that can be included in the fund. To be considered, companies must demonstrate a remarkable commitment to dividend payments by having a minimum of 10 consecutive years of payments. In addition, they must have a market capitalization of at least $500 million. Lastly, they must meet specific liquidity criteria.

Next, the holdings are then chosen by analyzing the companies with the highest dividend yields. They work their way through the list to determine which companies have the best cash flow to total debt ratio, return on equity, and what the 5-year dividend growth rate looks like. I think this is a solid line up within the top ten holdings since a lot of these names have been performing relatively well. Here are some examples:

• Broadcom: Recent earnings estimate beat & up 103% YTD.
• Home Depot: Has a dividend payout ratio of only 13%.
• PepsiCo: Has increased dividends for over 50 consecutive years.

The portfolio consists a lot of heavy hitting names that has great dividend history. Something I like is that a lot of the holdings have conservative payout ratios below 50%. This leaves lots of room for future dividend growth in these companies which will inevitably result in raises for SCHD as well. Therefore, I have no doubt that SCHD will continue delivering strong dividend growth to their shareholders.

Dividend

With an annual payout of $2.66/share, the current dividend yield sits around 3.5%. By my standards, this is considered low when you taking into account that high yield savings accounts are commonly paying above 4.5% these days. Despite this, at least the dividend growth story here is solid. The dividend growth CAGR over the last five year period is 13.05%. In addition to this growth, the fund has successfully increased their dividend payout for 12 consecutive years.

You can the see the dividend has increased a whopping 110% over the last 5 year period. This is what the fund is all about and I don't see any roadblocks stopping the growth from continuing. This is especially true when we look at the dividend growth of some of the top ten holdings.

• AVGO has a 5-year dividend CAGR of nearly 20% while maintaining a payout ratio below 50%
• Chevron has increased dividend payments for 36 consecutive years and previously announced buybacks totaling $75B
• Amgen recently raised their dividend by 5.6%
• Coca-Cola has increased dividend payments for over 61 years.
• Merck recently increased their dividend by 5.5%.

The Downside

There's no doubt that SCHD makes a for a quality holding. However, it's essential to note that SCHD tends to have a comparatively lower exposure to the technology sector. Given the substantial growth within the tech industry, the fund's relatively limited allocation to this sector may lead to missed opportunities for capitalizing. Don't get me wrong, I totally understand that the strategy the fund follows eliminates the possibly for tech exposure since most tech companies aren't exactly known for their consistent or generous dividend policies.

My point is, the technology sector has been a key driver of market performance for a lot of indexes. With SCHD placing a stronger emphasis on dividend yield and stability, it may not fully capture the dynamic and transformative nature of the tech sector. But this is completely fine as this isn't a goal of the fund to begin with.

Furthermore, the anticipated scenario of lowered interest rates in 2024 adds an additional layer to this consideration. Historically, technology stocks have exhibited sensitivity to interest rate movements. As interest rates decrease, the present value of future cash flows for growth-oriented assets tends to increase. If interest rates get cut three times as expected in 2024, it could create a favorable environment for the appreciation of tech stocks.

SCHD's conservative approach, prioritizing dividend stability, may inadvertently result in missing out on the potential upswing in tech stocks driven by lowered interest rates. This may be a downside but I don't necessarily believe it's something to stress about for every investor. There are lots of dividend investors who only prioritize consistently increasing income and don't focus on price appreciation.

Takeaway

Schwab U.S. Dividend Equity ETF ( SCHD ) represents a compelling option for investors who prioritize reliable cash flow through dividends. With a history of delivering both high total returns and substantial dividend growth, SCHD has proven itself as a solid choice, particularly for those who may be new to dividend-focused investing or seek a dependable anchor position in their portfolio.

However, it's crucial to acknowledge that SCHD has a relatively lower exposure to the technology sector, a significant driver of market performance and innovation. While there's nothing inherently wrong with this, it could result in missed opportunities for capitalizing on the dynamic growth of technology companies.

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