SCHD: Portfolio Rebalances Are Part Of The Process

seekingalpha04-05

SCHD is a top dividend-growth-focused ETF that provides exposure to high-quality companies across industries.The ETF follows a formula that filters for dividend growth, with low management fees of ...

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Rouzes Overview In my opinion, this dividend ETF remains the king of all dividend growth focused ETFs. With this ETF, you gain instant exposure to some of the best companies in the world across all industries. I previously covered Schwab's US Dividend ETF (NYSEARCA:SCHD) back in December of last year. Since then the holdings have been reconstituted and now the portfolio is a bit different than when I initially covered it. Despite these changes, SCHD is still a buy in my book. Data by YCharts We can see how SCHD has underperformed the S&P 500 (SPY) over the last 5 year period as the price has suffered since the pandemic drop. However, I believe this to only present a more attractive opportunity to establish a position in this quality ETF. The funds goal is to track the total return of the Dow Jones US Dividend 100 Index before any fees and expenses. Speaking of expenses, the management fees are quite low at only 0.06%. SCHD measures and filters through dividend paying companies that are included in the Dow Jones US Dividend 100 ETF but strategically focuses on a formula of dividend growth. The formula takes the following metrics into account before including the company as part of its holdings.  Established track record of paying high dividends for at least 10 years. Have a minimum market cap of $500M while also meeting the liquidity criteria. Cash flow to total debt - favors stock with little leverage. Return on equity - stocks that produce high earnings. The current dividend yield. What the 5-year dividend growth rate looks like. Excludes REITs (real estate investment trusts)  In addition to these filtering metrics, no single stock can be more than 4% of the total portfolio makeup and no sector can represent more than 25% of the index. If you're investing in SCHD, you have to be a believer in Schwab's formula here. There are no active fund managers here taking control of the holdings. As a result, the portfolio can be rebalanced and the holdings can change. Reconstitution - Updated Holdings SCHD's portfolio composition is reviewed annually and then rebalanced quarterly based on the previously mentioned criteria. As a result, we've recently experienced a reconstitution of the index alongside changes made to the DJ U.S Dividend 100 Index in early March. There are some additions and losses because of this rebalance and it seems that some people have mixed feelings about that. The rebalance saw the addition of 23 stocks as well as the removal of 23 stocks. For reference, here are the full list of stocks that have been removed alongside the previous weight in accounted for. Removed - 23 Stocks  Broadcom (AVGO): 4.90% Merck & Co. (MRK): 4.36% Automatic Data Processing (ADP): 2.96% Blackstone Group (BX): 2.61% Illinois Tool Works (ITW): 2.15% 3M (MMM): 1.68% Allstate Corp. (ALL): 1.23% Newmont Corp. (NEM): 1.16% Williams-Sonoma (WSM): 0.54% Northern Trust (NTRS): 0.49% Tyson Foods (TSN): 0.47% NRG Energy (NRG): 0.43% Kellogg (K): 0.41% International Paper (IP): 0.37% First American Financial (FAF): 0.17% Paramount Global (PARA): 0.16% Advance Auto Parts (AAP): 0.14% Lazard (LAZ): 0.13% Federal Agricultural Mortgage (AGM): 0.05% Stewart Information Services (STC): 0.05% Sturm, Ruger & Co. (RGR): 0.02% Ennis (EBF): 0.01% Hanmi Financial (HAFC): 0.01%.  Out of this batch of deletions, it seems that the removal of companies like Broadcom (AVGO) and Federal Agriculture Mortgage Corp (AGM) are two that stand out to me. Broadcom has an amazing dividend CAGR of 17.5% over the last five years, albeit a very low starting yield of 1.5%. AVGO is up in price nearly 350% over the last five years as well so removal of this company may mean that SCHD captures less upside considering we are only at the start of a growing AI industry. In addition, AGM is a company that may not be as well known but their fundamentals are very strong. For example, they recently announced a massive 27.3% dividend raise, making the five year dividend CAGR 14%. Alongside this massive raise, the price of AGM shares have appreciated over 150% during the same time period. So while I do understand the criticism that the reconstitution may have eliminate some heavy contributors, we may be judging too soon as the new batch of holdings may have similar results. In addition, there are plenty of companies on this deletion list that I am glad to see gone. Companies like 3M (MMM) and Paramount Global (PARA) have suffered to see any kind of growth as of recently. PARA was recently downgraded to junk rating due to the quality of their long term debt and their dividend growth has been shrinking because of cuts. Similarly, MMM has increased their dividend for over 65 consecutive years. However, that growth has been poor recently due to shrinking cash flow and a slew on ongoing lawsuits. The price has also fallen over 55% over the last five year period with a limited amount of catalysts that can help boost the price back to their previous highs. It's safe to say that MMM is no longer the dividend king it was once since confidence and quality has deteriorated. Additions - 23 Stocks  Bristol-Myers Squibb (BMY): 4.03% Hershey (HSY): 1.21% Cincinnati Financial (CINF): 0.79% Skyworks Solutions (SWKS): 0.69% CF Industries (CF): 0.67% DICK's Sporting Goods (DKS): 0.54% Tapestry, Inc. (TPR): 0.45% East West Bancorp (EWBC): 0.44% APA Corp. (APA): 0.41% HF Sinclair Corp. (DINO): 0.39% C.H. Robinson Worldwide (CHRW): 0.36% Vail Resorts (MTN): 0.35% Nexstar Media Group (NXST): 0.22% Columbia Banking System (COLB): 0.16% Insperity (NSP): 0.15% Lakeland Financial (LKFN): 0.07% Virtus Investment Partners (VRTS): 0.07% Heartland Financial (HTLF): 0.05% AMERISAFE (AMSF): 0.04% German American Bancorp (GABC) Preferred Bank (PFBC): 0.04% First Bancshares (FBMS): 0.03%.  Conversely, here are some of the companies that were added and I think will be hugely beneficial. Cincinnati Financial Corporation (CINF) and Bristol-Myers Squibb serve as two of the largest addition that stand out to me. CINF has been a consistent performer with exceptional revenue growth alongside a consistently growing dividend. Unlike MMM, CINF has earned that dividend king status with over 63 years of consecutive raises and confidence that their streak can still continue is high due to the sizeable raises. Although the starting yield of CINF is only 2.7%, the dividend grows at an average CAGR of over 7.3%, which is impressive for a company on this long of a streak. BMY serves as another addition that can successfully contribute to SCHD's success. The starting yield here is 4.6% and the dividend as grown at an average CAGR of 7.6%, which is more than acceptable for a stock that already has a higher starting yield. While the price has come down significantly since 2023, this only means that SCHD has managed to accumulate shares of BMY at a more attractive level as the company still manages to have great profitability metrics. At the end of the day, SCHD is following a set formula for their portfolio composition. If you don't believe in the formula, stay away from SCHD and pick your individual stocks. The formula they use to filter the 104 holdings has succeeded so far in providing a pleasurable total return. SCHD's total return is more impressive when you consider the fact that these returns were accomplished without the help of the growthier tech based stocks such as Apple (AAPL), Tesla (TSLA), Amazon (AMZN), or Microsoft (MSFT). Data by YCharts A criticism I see is that this reconstitution has included companies that have fallen in the short term. Like the BMY example, these prices may have seen short term noise due to changes in the sector, temporary declines in revenue, or even sensitivity to interest rates. However, the underlying fundamentals have been strong. Therefore, the reconstitution only added great companies at attractive valuations and we may benefit great over the next couple of years. Dividend The current dividend yield is 3.4% and while that's lower than the usual high yields of business development companies and REITs I frequently cover, the starting dividend yield isn't where the value lies. The value of SCHD lies within the historical dividend growth rate. We can see how the dividend growth of SCHD outperforms the S&P 500 as well as some peers like Vanguard's Dividend Appreciation ETF (VIG) and Vanguard's High Dividend Yield ETF (VYM). Over the last decade, the dividend has grown by a whopping 402%. Data by YCharts Over the last five year period, the dividend has grown at CAGR 11.80%. Even zooming out to a ten year period, the dividend has grown at a CAGR of 10.87%. If the criteria that SCHD bases its portfolio on maintains a dividend growth range between 8% - 12%, I would be very happy with that kind of growth. Alongside the growth, SCHD has been impressively consistent with the dividend payments. So far SCHD has managed to grow the dividend for 12 consecutive years. Most investors get involved with a dividend focused ETF like SCHD because of the income that it can provide. You can't really argue against the fact that SCHD has provided exactly that: a growing source of tax efficient dividend income. For clarity, dividends received from SCHD are classified as qualified dividends. Using Portfolio Visualizer, we can see the growth in dividend income from an initial investment of $10,000. This chart also assumes that all dividends were reinvested during the holding time and no additional capital was deployed.   Portfolio Visualizer Starting in 2012, your initial investment would have only net you $313 in dividend income annually. Through the growth provided over the decade, we can see how that original $10,000 investment would now be netting you over $1,400 annually in dividend income, assuming dividends were reinvested during that time period. The final results are even better if you contribute a fixed amount every month. Therefore, SCHD serves as an excellent choice for the investors with time on their side. From this perspective, the fund delivers exactly what it aims to achieve. Downside While the dividend growth has been immaculate, the downside is that this fund requires time to be on your side. For the investor that's nearing or at retirement, they don't have the luxury of waiting for the compounding of the dividend to happen. These investors that are more reliant on yield require a higher starting dividend up front. For these situations, SCHD's downside is that the starting yield of 3.4% typically isn't large enough to produce any meaningful income and dividend growth isn't nearly as important. Even if an investor held $1M worth of SCHD, the dividend income would amount to $34,000, which still falls below the median income in the USA and surely isn't enough to support the cost of living in most medium & high cost of living cities. Takeaway SCHD still serves as a great ETF choice for investors looking to capture high levels of dividend growth. The reconstitution may have eliminated some popular companies from the holdings, but popular does not always mean correct. The rebalancing of the portfolio added a ton of quality names that have excellent dividend growth history with strong levels of cash flow to support. The starting yield of 3.4% may be on the lower end of the spectrum but the magic here is all in the dividend growth that happens year after year. On average, we can expect the annual dividend to grow anywhere between 8 - 12% based on the historical data.  While the total return of an S&P index may be higher over the long term, SCHD has the ability to provide high levels of income to support you during your later retirement years through the high levels of growth if held through long periods of time and more capital is consistently deployed. However, if you require large amounts of dividend income now, SCHD is likely not the right ETF of choice for you since it would require larger amounts of up front capital to get a size of passive income that is large enough to support the average cost of living.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2425556070"}