QQQ - SCHG Vs. The Competition: How This Large-Cap Growth ETF Stacks Up

2023-04-08 08:00:00 ET

Summary

• SCHG is one of the top-performing large-cap growth ETFs over the last decade. With a 0.04% expense ratio, it's likely on your short-list.
• This article evaluates SCHG's fundamentals against other popular alternatives like VUG, SPYG, IWF, and QQQ.
• SCHG has highest price-earnings ratio in this sample but also the highest estimated earnings growth rate. Your decision should reflect how quickly you think growth stocks will rebound.
• Growth stocks are still out of favor, and I don't think a turnaround is imminent. However, it will happen eventually, and I hope this article helps prepare investors accordingly.

Investment Thesis

Many factors contributed to the decline of growth stocks last year, including declining earnings surprises and higher interest rates. However, the Schwab U.S. Large Cap Growth ETF (SCHG) should be on your shortlist for when market sentiment inevitably turns around. Its 284% gain over the last ten years places it atop the leaderboard among diversified large-cap growth ETFs, and its 0.04% expense ratio makes it an affordable pick for passive investors.

This article closely examines SCHG's fundamentals and how they compare against other top-performing growth ETFs. SCHG has a higher growth profile than most peers, which comes with a higher valuation. Unfortunately, large-cap growth stocks have poor earnings momentum, indicating it's not the right time to buy SCHG or the similar funds described in this article. Therefore, I'm reiterating my cautious view on SCHG from December 2021, and I look forward to taking you through the latest numbers next.

SCHG Overview

Strategy Discussion

SCHG tracks the Dow Jones U.S. Large-Cap Growth Total Stock Market Index, launched on February 28, 2005, nearly five years before SCHG. According to the Index fact sheet , the Index is float-adjusted market-cap-weighted and rebalances quarterly each March, June, September, and December. The selection process is described in the Index methodology document , which I've summarized below.

• Only common stocks of U.S. companies are eligible.
• Companies ranked in the top 600 by full market capitalization automatically qualify for the large-cap segment, with the preference given to current holdings until the total count reaches 750 (20% buffer rule).
• Securities are assigned a style score based on six growth and value factors described below:

Style purists will appreciate how there is no overlap between SCHG and the Schwab U.S. Large Cap Value ETF ( SCHV ). Vanguard's CRSP Indexes overlap, as do the S&P 500 and Russell 1000 style indices. I suggest SCHG's approach for investors who know what they want. Others who desire a less aggressive growth approach should consider the Vanguard Growth ETF ( VUG ), the SPDR S&P 500 Growth ETF ( SPYG ), or the iShares Russell 1000 Growth ETF ( IWF ). As I will demonstrate later, these ETFs typically have lower growth profiles and are slightly discounted.

The screens described above are reasonable. A mixture of expected and trailing growth and valuation ratios is helpful in fast-changing markets. Large-cap stocks are more mature, so perhaps historical measures are sufficient. Still, several smaller companies in SCHG have substantially different historical and expected earnings growth rates. Therefore, a "when in doubt, use both" approach is logical.

Sector Exposures and Top Ten Holdings

The following table highlights sector exposure differences for SCHG, VUG, SPYG, and IWF. I also included the Invesco QQQ ETF ( QQQ ), as it's the only large-cap growth ETF to (substantially) outperform SCHG over the last ten years. Its composition is different, but I included it because it's an obvious choice for growth investors.

All ETFs have high Technology sector exposure. QQQ's 49% is the biggest, which explains why it was the best-performing over the last decade. However, SCHG's 15% Health Care Exposure stands out compared to VUG, IWF, and QQQ. It also has above-average Financial sector exposure (8%) and 12% in Communication Services. The SPDR S&P 500 Value ETF ( SPYV ) includes Meta Platforms ( META ) now, which helps explain SPYG's low exposure to the sector. Despite similar long-term returns, these ETFs have more than a few interesting differences. You might have a preference based on these sector exposures alone, but I'll look to supplement with up-to-date fundamental statistics for each ETF later.

The following is a list of SCHG's top ten holdings, which total 52% of the portfolio. The list includes the usual suspects like Apple ( AAPL ), Microsoft ( MSFT ), Amazon ( AMZN ), and Alphabet ( GOOGL , GOOG ). UnitedHealth Group ( UNH ) is the leading Health Care stock, but there is also AbbVie ( ABBV ), Eli Lilly ( LLY ), Thermo Fisher Scientific ( TMO ), Danaher ( DHR ), and Elevance Health ( ELV ) inside the top 25. Visa ( V ) and Mastercard ( MA ) are now reclassified to Financials from Technology after last month's GICS changes took effect.

Performance

The following table summarizes historical returns for some of the most popular large-cap growth ETFs, including the ones discussed above. I've sorted this list by ten-year returns, and SCHG's 284% return ranked sixth-best. QQQ was easily the top performer with a 410% return, and the iShares Russell Top 200 Growth ETF ( IWY ) beat SCHG by 34%.

The last column highlights each ETF's ten-year return-to-risk ratio, which I calculated by dividing the fund's annualized returns by its annualized standard deviation (using monthly returns). It's similar to the Sharpe Ratio but doesn't account for the risk-free rate. SCHG's 0.85 figure is excellent and competitive with nearly every other peer except for QQQ and IWY. VUG is the outlier at 0.79, so if you value a solid track record, you might want to remove it from your shortlist. Here are some additional statistics for how SCHG ranks over each period:

• 6M: #12/30
• 1Y: #15/30
• 3Y: #6/23
• 5Y: #7/21
• 7Y: #6/19
• 10Y: #6/19
• 10Y Return-To-Risk: #6/19

I view these results positively. Over no period is SCHG near the bottom of the rankings. It's struggled over the last year, but even a middle-of-the-pack score is admirable. Looking at the funds that outperformed during this period, the most successful ones stayed away from mega-cap stocks one way or another. The Invesco S&P 500 GARP ETF ( SPGP ) avoided them with a valuation screen, and the two Nasdaq-100 Equal-Weight ETFs ( QQQE and QQEW ) did so with an alternative weighting scheme. I warned of the dangers of mega-cap growth stocks in my review of SCHG in December 2021 . However, for long-term investors, it still looks like an above-average choice.

SCHG Analysis

Fundamentals By Company

The following table highlights selected fundamental metrics for SCHG's top 25 holdings. I included growth metrics to highlight how well SCHG performs against its peers and the SPDR S&P 500 ETF ( SPY ) on the growth factor. However, investors less in tune with how well-rounded their portfolios are may want to consider other factors, including volatility, valuation, and profitability.

SCHG has the best overall growth metrics, evidenced by its 10.83% and 17.22% estimated revenue and earnings growth rates. SPYG's constituents grew earnings per share by an annualized 18.82% over the last three years, so it's also a solid growth fund. However, that metric is similar to what S&P Style Indices screen for, so it's unsurprising. I favor forward-looking metrics, but using historic and expected growth metrics is a reasonable compromise. These are large, mature companies, so past results should carry some weight.

All five growth ETFs have similar weighted average market capitalizations, your first indication that trillion dollar companies like Apple, Microsoft, Alphabet, and Amazon, are prominent. I don't think there's a good way to sufficiently avoid these stocks without sacrificing quality. All growth ETFs have profitability scores around 9.50/10 or better, indicating that they're slightly higher in quality compared to SPY. This metric gives me confidence that all these ETFs will be successful over the long run.

The issue today is valuation. For example, QQQ trades at 30.53x forward earnings and has an estimated 8.85% earnings per share growth rate. SPY trades at a 6.33-point discount on forward earnings and has an estimated earnings growth rate of 8.02%, just 0.83% less. Given these statistics, I wonder why growth investors would choose QQQ over SPY. I've made this basic observation since January 2022, and even with tech stocks' unexpected 2023 rally, QQQ is still behind by approximately 7.5% . The takeaway is that at some point, you need to consider valuation. Growth ETFs don't do that by design, so this extra layer of analysis is necessary.

Turning back to SCHG, it trades at 31.39x forward earnings, the highest of the six funds listed. However, remember that you're at least getting solid historic and expected growth for that valuation. Therefore, if you're bullish on growth stocks, SCHG makes sense compared to the competition. However, if you're uncertain like I am, you may not be willing to pay a 7.19-point premium on forward earnings for 3-4% extra revenue and earnings growth.

The main reason why I'm not sold on growth stocks is because most failed to deliver strong earnings beats over the last year. Consequently, analysts are downgrading earnings estimates for growth stocks faster than the overall market, reflected by SCHG's poor 5.23/10 EPS Revision Score. Consider the following table highlighting the quarterly earnings surprise trends for SCHG's top 25 holdings.

The table includes earnings surprises for the last eight quarters, and they've generally been trending downwards for over a year. The median surprise in Q1 2021 was 11.43%, but just 3.19% in Q4 2022. Yardeni Research confirms this downward trend, reporting the following aggregate S&P 500 figures over the last five years.

It's no wonder markets soared after the Q1 2020 crash. Earnings surprises were enormous, the biggest since 2009 after the Great Financial Crisis. Apple, Alphabet, and Amazon were the most significant contributors but missed earnings expectations last quarter. These companies need to surprise to the upside first before market sentiment turns around in favor of growth stocks. When that eventually happens, SCHG should thrive.

Investment Recommendation

This article compared SCHG with several other top-performing large-cap growth ETFs. I determined that it has a higher estimated earnings growth rate than peers VUG, SPYG, IWF, and QQQ but also the highest valuation. The reasons include a screening process that considers forward-looking growth rates and a style selection that has no overlap with its large-cap value counterpart. Its 0.04% is low and a great choice for those wanting specific exposure to the growth factor.

Still, I don't recommend buying SCHG or any of these four peers today. Growth stocks have yet to deliver on earnings for several consecutive quarters, and analysts have downgraded future earnings expectations. In short, growth companies, especially the trillion-dollar ones, haven't given us any reason to be bullish anymore. Until that happens, it's prudent to be cautious. Thank you for reading, and I look forward to the discussion below.

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