SCHD: If You've Won The Game, Take A Little Off The Top

seekingalpha04-22

SCHD is a great capital gains storage for positions that may be getting over-concentrated in your portfolio.Many investors have big winners from buying the dips in 2020 and 2022.Chances are your ...

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SCHD is a great way to reduce the overall P/E ratio of your portfolio amongst 100 quality dividend-paying stocks.At a 3.53% yield, SCHD has a higher yield than most single shares of blue chip names available, including the energy sector, which is one of the cheapest in the market.   Jon Feingersh Photography Inc/DigitalVision via Getty Images Time for a shave It has come the time to count one's blessings. Those who have bought and held shares of a lot of demolished blue chip stocks since the fortuitous bottoms in 2020 and 2022 have a lot to be thankful for. Yes, it takes some skill to identify single shares that are both \"cheap\" and have the prospects of snapping back to their all-time highs with even some extra growth baked into boot. While I preach buy and hold and have almost no turnover per year in my portfolio [I aim for less than 5%], there comes a time when reducing winners does not equate to \"picking the flowers and watering the weeds\" as Peter Lynch would say. As I sit on a few of these winners, I have been sorting through and making a few reductions, stuffing the winnings into various index funds. Namely State Street and Vanguard's S&P 500 index funds (SPLG) (VOO), Invesco's Q's fund (QQQ), and of course, Schwab's U.S. Dividend Equity ETF (NYSEARCA:SCHD). Of the lot, SCHD is the cheapest index with a P/E ratio of only 14.5 X:   Yahoo Finance Some common winners  NVIDIA (NVDA) Exxon Mobil (XOM) Apple (AAPL) Meta (META) Super Micro (SMCI)  Above are just a handful of names where if timed right during either the flash crash of 2020 or the tech bear market of 2022, you have hit some nice low to mid multi-baggers from a total return perspective.  While I didn't buy all the stocks on this list, these are just the most common ones that come to mind. Tesla was also up there for a while, but we all know that story.  Sort your leaderboard and look at the earnings multiples, see if it's worth shaving a bit off or if they still meet your projections. Most of my winners still fit within a reasonable value spectrum, but I have begun to reduce a few in case the growth stories subside. While oil seems a great value right now, the cyclicality of oil prices may prove otherwise. The rising prices in oil allow investors to evaluate a reduction based on the higher prices of the underlying commodity. Locking in your gains on a dividend stock [oil & gas], while diversifying into a dividend fund like SCHD, which now has a higher yield than most oil stocks, is not a horrible choice for diversification. A note from John Bogle Index funds have not always averaged such an expanded multiple, and thus their dividends have represented a larger portion of the total return traditionally than they do now. Usually, a higher multiple = lower dividends and vice versa. A few excerpts on Dividends from John Bogle's The Little Book of Common Sense Investing pages 65-66: Dividend yields are a vital part of the long term return generated by the stock market. In fact, since 1926 (the first year for which we have comprehensive data on the S&P 500 index), dividends have contributed an average annual return of 4.2%, accounting for fully 42 percent of the stock market's annual return of 10 percent for the period.- John Bogle and Compounded over that long span, dividends made a contribution to the market's appreciation that is almost beyond belief. Excluding dividend income, an initial investment of $10,000 in the S&P 500 on January 1, 1926, would have grown to more than $1.7 million as 2017 began. But with dividends reinvested, that investment would have grown to some $59.1 million!- John Bogle Yes, in the short term the earnings growth of a company, and thus growth funds, can dominate returns over dividend-centric funds. In the long run, after growth peters out, dividends become a larger and larger share of the total return. I am by no means saying that SCHD is a superior fund to SPY or VOO, but the current multiples have now compressed the starting yield down to 1.4% with lower dividend growth rates for SPY and VOO vs a 3.53% yield on SCHD. If we're thinking decades into the future, SCHD may not be such a bad deal after all and a great place to park some of your winnings and lower your portfolio P/E ratio. Hedge against a bubble From a previous article of mine on how to invest $1 million for retirement, value funds have outperformed in persistent bear eras such as the lost decade of 2000-2010, the chart below represents the first tranche of the decade returns from 2000-2005:   2000-2005 (Portfolio Visualizer) In this demonstration, the model portfolio was split into a pie in 3rds across SPY (SPY) The SPDR Dow Jones Industrial Average ETF Trust (DIA), and Berkshire Hathaway (BRK.B)(BRK.A). The goal was to maintain a possibility to gain alpha via including SPY while protecting one's downside with diversified values like the Dow 30 and Berkshire Hathaway. If we just look at the total returns of the Dow 30 and Berkshire Hathaway versus SPY, we would see even better outperformance:   2000-2005 BRK and DIA VS SPY (Portfolio Visualizer) The result in this 5-year period post dot com bubble bursting was a 4.6% CAGR for Berkshire Hathaway plus the Dow 30 ETF versus negative -1.22% per year for SPY. SCHD did not exist in this era, but if it did, the strategy of value and income would have had a great chance to perform as well or better. Why not just play money markets, then? Fair question, a 5% risk-free return is great and may last for quite a while. Even 4+% would be a great deal compared to a risk-on investment in a possible bear market scenario of 4.6%. If only it was that simple.  Predicting interest rate trajectories is next to impossible. Additionally, conservative or not, SCHD and other value funds will do a great job of capturing the bulk of the S&P 500 total returns should the bull market keep running and most likely outperform should the market turn bearish. In my opinion, this proposition is far less risky than a long-term cash position. While I do keep a good chunk of cash getting 5%, I don't think it's a great place for reinvested capital gains of equity winners. It's just a great place to store new capital that you might not be ready to invest. Constituents post reconstitution: SCHD just went through a portfolio reconstitution, as is the mandate of the ETF. The new top 10 holdings look like this: From schwabassetmanagement.com: New top 10 entrants in bold [top 10 = 40.19% of holdings]:       As-Of-Date Symbol Quantity Percent of Assets Name   4/19/24  (LMT) 4947896 4.25492543 LOCKHEED MARTIN CORP   4/19/24  (CVX) 14046660 4.17318239 CHEVRON CORP   4/19/24  (PEP) 12811281 4.16124178 PEPSICO INC   4/19/24  (TXN) 13124803 4.05025675 TEXAS INSTRUMENT INC   4/19/24  (CSCO) 44524919 4.03886351 CISCO SYSTEMS INC   4/19/24  (VZ) 53363289 4.03768488 VERIZON COMMUNICATIONS INC   4/19/24 (KO) 35428282 3.93513643 COCA-COLA   4/19/24  (UPS) 14481070 3.89732854 UNITED PARCEL SERVICE INC CLASS B   4/19/24  (BMY) 42024111 3.82706956 BRISTOL MYERS SQUIBB   4/19/24  (AMGN) 7712355 3.82076605 AMGEN INC   Click to enlarge This is a 100 stock index with a weighting system that has a few variables.   S&P Dow Jones Indices Vs. top 10 Previous to the current 2024 reconstitution- top ten 2023 holding exits in bold:  Amgen- Health Care AbbVie- Health Care Chevron- Energy Pfizer- Health Care PepsiCo- Consumer Staples Merck & Co- Health Care Broadcom- Information Technology Texas Instruments- Information Technology Coca-Cola- Consumer Staples Cisco-Information Technology  Old sector formation top 10:  4 Health Care 1 Energy 2 Consumer Staples 3 Information Technology  New sector formation top 10:  2 Industrials- Aero Space and Defense and Air Freight and Logistics 1 Energy 2 Consumer staples 2 Health Care 2 Information Technology 1 Communication Services  Broadcom is now out of the top 10, as are Pfizer, Merck & Co, and AbbVie. Bristol Myers Squibb and Amgen remain as the last two big Health Care pharma names, UPS joins the top 10 as does Lockheed Martin at the top representing Industrials. The top 10 added two new sectors, with Industrials and Communication Services. SCHD has cut healthcare exposure in half within this top 40% slice, and IT has been slightly reduced. Current dividend and growth rate   Seeking Alpha SCHD has been growing its yield since inception circa 2011. Those who bought and held since the fund was offered now enjoy a 10+% yield on cost. Although the 3-year dividend growth rate now trails its 5 and 10 year averages, an 8.56% growth rate is still pretty healthy. 10 year Performance versus the S&P 500 Data by YCharts Looking at the 10-year total return trajectory of SPY versus SCHD, we see a pretty good-sized outperformance 10 years to date. 221% for SPY versus 179.2% for SCHD. The question is when did SCHD outperform? Data by YCharts This period demarcates April 1 2022-April 1 2023. Somewhere between the mid-point and the end of the tech bear market. SCHD had its head above water for a period during this downturn, during which SPY got as low as -20% off its highs. The current relative underperformance of SCHD may be seen as a positive hedge if you think the 21 X forward multiple of the S&P 500 is not sustainable for much longer. I am not sure about the sustainability of it, but I continue to buy SCHD, especially with funds from portfolio reduced winners, to hedge the possibility that multiple expansion will not last forever. Versus the Dow 30 Data by YCharts In fact, on a 3-year basis during the series of buying opportunities and upward bull market movements, SCHD has underperformed even the Dow 30. This is largely due to the Dow 30 now mimicking the S&P 500 at a closer and closer clip adding more big tech and high multiple names, this is something which is outside the historical norm for the index. A few of these non-value names include:  Salesforce (CRM) TTM P/E 64 X Apple (AAPL) TTM P/E 26 X Microsoft (MSFT) TTM P/E 36 X  The above doesn't even include the recent addition of Amazon (AMZN) and jettison of Walgreens (WBA). In short, the Dow is not the historical \"value\" index that it once was, it's more or less S&P 500 \"lite\".   Yahoo Finance The Dow 30 now sports a 22.48 X TTM P/E ratio versus SCHD's 14.5 X. The Dow 30 P/E ratio is now only slightly cheaper than SPY, which is sporting a 24.94 X TTM P/E ratio. Here are the P/E ratios of a few more \"value\" ETFs:   Vanguard High Dividend Yield Index Fund ETF Shares (VYM) 15.87 X   Invesco S&P 500® Equal Weight ETF (RSP) 20.33 X   ProShares S&P 500 Dividend Aristocrats ETF (NOBL) 21.27 X   As we can see from the above, SCHD provides a cheaper P/E multiple than most \"value\" funds.  Admittedly, I am nearly as heavily invested in DIA as I am in VOO from a buy-and-hold strategy I started over a decade ago with not one share liquidated. The purpose of buying DIA was to lower the overall P/E ratio spread. However, DIA is becoming less and less a hedge against the higher S&P 500 multiple and more and more a clone. I don't plan to sell any shares of DIA, but SCHD is beginning to replace this thesis as a lower multiple hedge. Other value funds don't appear to be real values at all. VYM would be the closest, with nearly an equal P/E to SCHD. Risks New normal? Massive earnings growth ahead for the magnificent mega-cap monopolies? Sure, diverting some funds for more conservative lower multiple ETFs can be an inherent risk all on its own if the market continues to run due to newly justified fundamentals that we can't always predict into the future. The forward P/E might be lower than we assume for the S&P 500, Nasdaq, and Dow.  Plenty of cash remains on the sidelines, when that first rate cut hits [if it hits] and if it's independent of a recession, multiples could continue to expand. SCHD has underperformed as of late and could continue to do so. Summary Look, we all know that P/E ratios are elevated. Chances are your winners have won due to greatly expanded multiples. There's nothing wrong with that, and those multiples may fit the bill should their earnings continue to compound. In my book, SCHD serves a purpose, be it long or short term, for a great capital gains storage when I take a few chips off the table. I rarely sell out of anything, but reducing my overall portfolio P/E ratio is something on my mind in times like these. Buy.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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