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Late-Cycle Nirvana: Moaty Dividends on the Cheap

With economic growth picking up a smidge, and seemingly stable enough for the Federal Reserve to get serious about a potential rate rise in the first half of next year, there’s little to suggest any need to get your inner bear on. But at the same time, with valuations anything but cheap, getting a bit more smart/defensive in your stock allocation seems like a reasonable pursuit.

Enter, the Schwab U.S. Dividend Equity ETF (SCHD). Its got the sort of high-quality large cap issues -- Johnson & Johnson (JNJ), Microsoft (MSFT) and Chevron (CVX) -- that participate plenty on the upside, but also have the nice habit of holding on better when the markets correct. And as Morningstar Analyst Abby Woodham recently noted in Morningstar magazine, about two-thirds of the portfolio is invested in stocks that have been designated by Morningstar to have a wide moat. That compares to less than 50% of the S&P 500.

For income investors, the Schwab US Dividend ETF does indeed provide a dividend yield premium to the SPDR S&P 500 ETF:

SCHD Dividend Yield (TTM) Chart

SCHD Dividend Yield (TTM) data by YCharts

The projected yield for the Schwab portfolio is an even more compelling 3.1%. (You can now find an ETF’s prospective yield on its main quote page, under the Fundamentals section on the right side of the page.)

The fact that the Schwab ETF has the lowest annual expense ratio -- a razor thin 0.07% -- of any dividend focused ETF helps it on the yield front. That even manages to out-cheap the 0.10% expense ratio of the Vanguard Dividend Appreciation ETF (VIG), as well as the 0.40% expense ratio for the iShares Dow Jones Dividend Select ETF (DVY) and the 0.35% tab for the SPDR S&P Dividend ETF (SDY).

Though the cheapest, the Schwab ETF is the smallest of the four, with assets of around $2 billion. But as you can now quickly check on YCharts expanded ETF quote page, the Schwab US Dividend ETF offers all the liquidity you need; its 30-day average trading volume is around 250,000 shares and the 0.03% recent premium is negligible.

The main quote page for stock ETF’s also gives you a great snapshot of portfolio quality. The Schwab US Dividend ETF has an average Return on Equity of 28% and its Return on Assets is above 9%. That compares to 21% and 8% respectively for the S&P 500.

The ETF tracks the Dow Jones U.S. Dividend 100 index. That benchmark whittles down 2500 stocks by insisting on basic size and liquidity hurdles and then tosses in a requirement for annual dividend payouts in each of the past 10 years (bye-bye Apple (AAPL).) From there the remaining candidates are ranked on quality factors including cash flow/debt, the 5-year dividend growth rate and current dividend yield. The 100 stocks that make the cut are then weighted by market cap.

Microsoft is the largest holding in the portfolio right now. From a quality standpoint, you can see how it makes the cut; yes, ROE and ROA have fallen, but there are a few thousand other companies who would die to be where Microsoft is today:

MSFT Return on Equity (TTM) Chart

MSFT Return on Equity (TTM) data by YCharts

And for dividend investors, Microsoft has delivered the ultimate two-fer: outsize growth that came in a steady stream.

MSFT Dividend Chart

MSFT Dividend data by YCharts

Like the Vanguard Dividend Appreciation ETF, the Schwab portfolio has less than 1% invested in utility stocks. That should be a bonus going forward as rising interest rates will put extra pressure on the slow-growth utility sector. Yield starved investors who migrated over from bonds in the wake of the financial crisis/rate repression are expected to do a reverse migration as bond yields head higher.

You can now find the sector breakdown for stock ETFs on the main quote page. Investors in the iShares Dow Jones Dividend Select ETF might want to take a long look at that portfolio’s asset breakdown: one-third is riding on the utility sector.

The Schwab US Dividend Equity portfolio has about 37% of its portfolio riding on the three sectors that historically perform well in the latter stages of a bull market: energy, technology and health care. That’s more than the 30% for Vanguard Dividend Appreciation. In addition to Microsoft, the Schwab ETF’s Top 10 includes Intel (INTC) on the tech front. Both Chevron and Exxon Mobil (XOM) represent for the energy sector in the top 10. And in health care, Johnson & Johnson and Pfizer (PFE) are in the top 10 as well. The portfolio’s 16 forward PE ratio is below the 17 for the SPDR S&P 500 ETF.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  dividend growth   ETFs   moats   dividends   bonds   income investing   

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