VV - SCHX: Doubling Down On Large-Caps

2023-04-18 06:27:47 ET

Summary

• SCHX is a popular large-cap focused ETF offered by Charles Schwab.
• Large-cap equities have significantly outperformed small and mid-caps over the past decade.
• SCHX records a 11.96% 10Y CAGR and pays a 1.57% dividend yield.

Thesis

After a turbulent 2022 for stocks, so far into 2023 the broader market seems to be on the recovery path, despite economic uncertainty and challenges persisting. Large-cap equities are getting a progressively larger share of investors' attention as the market becomes more and more concentrated. In this analysis, I explore the attributes and performance characteristics of a popular large-cap ETF, Schwab's U.S. Large-Cap ETF ( SCHX ), one of many popular investor choices in the large-cap equities universe offered by Charles Schwab ( SCHW ). Throughout the analysis, I explore some basic characteristics of the ETF, the positioning and overall valuation of large-caps comparatively to small and mid-caps, as well as SCHX's relative performance attractiveness.

Fund Overview

Schwab's U.S. Large-Cap ETF offers investors exposure to over 700 large cap U.S. companies, at a very low 0.03% expense ratio. It tracks the total return of the Dow Jones U.S. Large-Cap Total Stock Market Index and pays a 1.57% dividend yield. While the large-cap space offers a wide range of choices, SCHX is still a relatively popular choice amongst investors, with over $30B of assets under management.

In terms of portfolio composition, SCHX is very similar to most large-cap funds or S&P 500 ETFs. Rather concentrated, the fund's top 10 holdings account for 25.4% of total weighting, with technology being SCHX's largest sector. Largest holdings include Apple ( AAPL ), Microsoft ( MSFT ), Amazon ( AMZN ) and others.

Large-caps Positioning and Valuation Through 2023

Large-cap equities have recoded significant growth over the past decade, as the U.S stock market has become more and more concentrated. Especially within the technology sector, larger companies are capturing the majority of growth either organically or through acquisitions.

Meanwhile, smaller, Russel 2000 companies are becoming more unprofitable over time as small-companies struggle to penetrate markets dominated by established players, across many sectors. Especially given the rising interest rate environment, small-cap companies are challenged to secure funding through financial institutions, while sector-leading firms are able to obtain lower-cost financing through a variety of instruments, including bond-issuance at lower rates.

Large-cap companies maintain, on average a 9.8x interest coverage ratio (EBIT/Interest Expense), while small-caps stand, on average at 2.6x. This wide and growing gap is a reflection of outperformance, both in terms of profitability and low-cost funding availability by large-caps.

Over the past decade large-cap equities have significantly outperformed their mid and small-cap counterparts. 10-year annualized large-cap blend returns stand at 12.2%, compared to 10.1% for mid-caps and just 8.0% for small caps. The same is also true, currently, in 2023, as YTD large-cap returns lead the market and since the broader market lows where recorded in 2020.

While someone would expect this prolonged run-up and outperformance for large-caps to translate into high valuation premiums today in the market, this is not entirely the case. Even though large-caps are the only size-classification of stocks to currently trade above their 20-year average P/E multiples, they are actually less expensive than small-caps (17.8 blend P/E vs 20.3x for small caps). What this means is, that despite their lacking performance over the past decade and their higher volatility, small-caps are currently more expensively priced, while large-caps still seem to offer an attractive entry point for investors.

SCHX vs. S&P 500

In the eyes of many analysts and investors a U.S Large-cap ETF will be almost identical to an S&P 500 index fund, as performance metrics are guided by the same mega-cap names that dictate market performance. Especially as the market is becoming more concentrated the largest companies in the United States leave almost no room for smaller equities to contribute to overall performance of a broader index fund.

By running a backtest comparing the performance of SPDR's S&P 500 ETF ( SPY ) with SCHX, using the tools offered by portfolio visualizer I was able to confirm this notion. Going back to late 2009, when SCHX was incepted, up until today, the two ETFs have performed almost identically. Recording a 12.52% CAGR, SPY has slightly outperformed SCHX (12.49%). SCHX also offers slightly increased volatility (14.88% standard deviation vs 14.76%) and a -24.74% maximum drawdown (vs -23.93 for SPY). Overall the differences are, in fact, rather negligible over this 12+ year period. Dividend reinvesting was assumed for the backtest.

Peer Comparison

The large-cap equities ETF universe is very broad and offers investors many good, low-cost options to choose from. In this segment I will provide a comparative analysis of a few ETF peers, including Vanguard's Large-Cap ETF ( VV ), iShares Russell 1000 ETF ( IWB ), SPDR's S&P 500 ETF ( SPY ) and, of course, SCHX.

Within the peer group SCHX is positioned relatively well in terms of performance, slightly behind SPY and VV, while it also carries the lower expense ratio and the higher dividend yield. SPY is the least expensive ETF (P/E of 19.78x) and the least diversified, with 505 holdings and 27.1% of total weighted attributable to its top 10 holdings. Performance and other metrics for the peer group are available in the table below.

Final Thoughts

After all things are considered, large-cap equities seem comparatively well positioned despite already having outperformed small and mid-caps over the past 10+ years. While many different large-cap ETFs are available for investors, SCHX is a solid choice, offering a very low expense ratio as well as strong performance since its inception in 2009. Overall, I would rate SCHX as a buy.

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