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The Schwab U.S. Dividend Equity ETF™ (NYSEARCA:SCHD) has started off 2024 with the same results as the last few years. In addition, the dividend growth investment vehicle added a huge reconstitution of stocks in the ETF, offering a hint at the long-term investing issues. My investment thesis remains Neutral on the fund consistently underperforming the market now.
Source: Finviz
SCHD is designed to closely mirror the performance of the Dow Jones US Dividend 100 Index (DJUSDIV). The index made substantial changes on the rebalancing on March 18.
The index saw the following additional deletions after Dow Jones initially proved an inaccurate list. The big news is that a couple of big positions were removed from the index: Broadcom Inc. (AVGO) and Merck & Co., Inc. (MRK).
Source: Twitter/X @SCHD STAN
Ironically, Broadcom just announced some exciting AI infrastructure products, though the stock has seen the dividend yield dip to only 1.7% with the stock trading at 26x forward earnings. Merck has rallied, pushing the dividend yield down to 2.5%, but the stock isn't necessarily expensive and the biopharma had a nice hike to the dividend.
The biggest issue with the index is the focus on strict requirements to enter the index with no real qualitative measure of value. Stocks meeting these below requirements tend to already trade at a premium valuation.
Source: Dow Jones
The IAD yield is the only partial measure of value included in the analysis and this only accounts for 25% of the selection criteria. While return on equity and dividend growth rates are strong attributes of a company, these measures don't provide any indication of whether the stock is attractive and the dividend yield is a reflection of what a BoD chooses to pay out impacted by stock price.
Even with the popularity of stock buybacks now, global dividends continue to reach record levels. Total global dividends grew 5% last year to reach a record $1.66 trillion. All of the Covid dividend cuts in 2020 were quickly replaced, and the forecast is for more dividend growth in 2024.
Source: Janus Henderson
Investors have plenty of dividend options. As this list highlights, the top performing stocks typically aren't the ones with solid dividend yields above 3%. The S&P 500 (SP500) is already up 9.9% this year, and the top performing dividend stocks barely top the index gains.
SCHD is only up 4.0% YTD, while the S&P 500 has a total return of 9.9%. For a normal quarter, SCHD has generated a solid performance, but the ETF continues to underperform the market, with the gap gaining steam from our last research.
After the reconstitution, most of the top stocks in the SCHD portfolio are still the same. The top 10 stocks still account for nearly 40% of the portfolio and most of the stocks have valuation issues, not surprising considering the ETF now trades at nearly 20x forward EPS targets.
Source: Schwab Asset Management
Some of the top stocks easily highlight the problem with SCHD. United Parcel Service, Inc. (UPS), PepsiCo, Inc. (PEP) and Texas Instruments Incorporated (TXN) all trade at elevated forward P/E ratios without the corresponding strong earnings growth. Both UPS and PepsiCo trade at roughly 20x forward EPS targets, with UPS earnings falling this year and PepsiCo only forecast to grow 7%. Texas Instruments is even worse with a 33x forward P/E ratio and earnings expected to slump in 2024.
The problem here is that UPS stays in the index by constantly hiking the dividend. The company recently hiked the dividend by just a cent per share to $1.63.
UPS has no business hiking the dividend with the company reporting 5 consecutive quarters of revenue declines. The package delivery company has had a tough spell following the Covid boost, but the stock isn't priced at any major discount to warrant a dividend index or ETF to favor UPS as the top portfolio holding.
PepsiCo has reported more consistent growth, but the stock is still expensive and the beverage company doesn't have the growth to warrant the larger forward PE multiple as recently covered here. Texas Instruments is probably an even worse case of growth not matching with the valuation.
The chip company has reported 5 consecutive quarters of revenue declines and analysts forecast another 3 quarters of weak numbers. At the end of the day, Texas Instruments is reporting quarterly earnings down some 50% from the highs in 2022, yet the company pays a 3.2% dividend yield from a $5.20 annual dividend.
As with the other stocks, Texas Instruments just recently hiked the dividend by ~5% to $1.30 per quarter. The chip company has no business hiking the dividend with the weak financial results, yet SCHD will lap up the stock due to the focus on dividend growth.
Other stocks in the top 10 of the SCHD portfolio have similar issues. Pfizer Inc. (PFE) has reported massive revenue dips, though the stock, along with other biopharmas, trade at more reasonable valuations. The ETD missed the opportunity to cash out of Pfizer at $60 after the Covid vaccine surge because SCHD and the Dow Jones Dividend index don't look at any valuation metrics, instead focusing on how the BoD again hiked dividends this year.
SCHD offers investors an attractive 3.4% dividend yield, and the ETF is likely to provide decent performance in the years ahead. The problem is that investors are paying relatively high prices in order to buy large-cap stocks with limited growth prospects, instead of generally buying large yielding stocks when unloved by the market.
The key investor takeaway is that Schwab U.S. Dividend Equity ETF™ is generally an ETF holding overvalued stocks trading at an average of 20x forward EPS targets. The ETF still manages to pay a decent dividend, but the stocks are starting to underperform the market on a regular basis due in part to favoring stocks playing the game of hiking the annual dividend despite financial results that don't warrant hikes.
Schwab U.S. Dividend Equity ETF™ is still too loved to buy the ETF here, and the reconstitution doesn't improve the view one bit.