Is SCHG A Good ETF And Is It An Attractive Bet Now? (NYSEARCA:SCHG)

ETF Profile

The Schwab US Large-Cap Growth ETF (NYSEARCA:SCHG) is a 14-year-old product, with $24bn in AUM, that offers coverage to large-cap US-based stocks, that exhibit growth characteristics. It’s fair to say that gaining access to SCHG’s 250-odd names won’t burn a hole in your pocket, as the expense ratio of this product is compellingly low at just 0.04%. There also appears to be an inherent stability to this portfolio, as represented by a lowly annual turnover rate of just 5%.

Note that SCHG tracks the Dow Jones U.S. Large-Cap Growth Total Stock Market Index, which is a subset of the Dow Jones U.S. Large-Cap Total Stock Market Index. Stocks that eventually make it to SCHG’s tracking index (the annual reconstitution for the index takes place every September) are ascertained on the basis of a certain style score, that incorporates six different screeners.

We feel that there’s a healthy balance with these screeners as it considers the past, the present, and the future of a certain stock before bringing it on board. For instance, two of those screeners are forward-looking, (the 1 year forward P/E, and the 3-5 year expected growth in the annual operating EPS), two are backward-looking (the 5-year annualized revenue growth and 21-quarter annualized EPS growth), and two focus on the status-quo (the current price to annual book value per share, and the current dividend yield).

How Has SCHG Fared Over Time?

On paper, one would think that this well-balanced screening mechanism could lead to the procurement of good-quality stocks, and so far at least it appears to have worked out quite well. To get a sense of SCHG’s worth, we thought we would highlight its performance against the most popular US large-cap growth ETF alternative- the Vanguard Growth ETF (VUG) which has amassed AUM that are over 8x higher than what SCHG has amassed.

Firstly, note that since SCHG made its debut in the markets back in Dec 2011, until today it has managed to outperform VUG. It may also be construed to be the less risky play of the two, although the difference between the volatility profiles of these two products isn’t meaningful.

The risk profile of an ETF can also be gauged by how well it fares when faced with bouts of harmful volatility. The Sortino ratio attempts to address this facet, and here what’s evident is that whether it over 10 years or over 3 years, SCHG has always managed to throw up better numbers than VUG.

Finally, the respective Sharpe ratio readings both over the long-term and the short-term highlight how SCHG does a better job of delivering higher excess returns for every unit of total risk taken (as measured by the standard deviation).

Is SCHG A Good Buy Now?

SCHG appears to be one of the better large-cap-focused growth ETFs around, but that does not necessarily make it a good buy at this juncture. Here are a few reasons why we feel investors should not be overzealous about SCHG’s prospects at this juncture.

Firstly, consider that the growth side of the large-cap universe appears to be very overextended and overvalued. The chart below provides some perspective on how large-cap growth stocks are positioned versus a diversified basket of large-caps. The current relative strength ratio is not only 15% higher than the mid-point of its long-term range, it has now also hit the 1.5x barrier, a level it has failed to clear on two separate occasions in 2020 and 2021. Note that the valuation differential between large-cap growth and general large-cap is around+35%, with SCHG priced at 27 P/E

Then, the dominant growth sectors – Tech and consumer discretionary stocks are also currently the priciest pockets in the market, trading at forward P/Es of 27.1x and 24.6x.

For tech in particular, the valuation situation is quite alarming with a 35% variance over its 10-year average. Yes, we recognize that the ongoing AI wave has no doubt triggered some serious re-rating in a lot of these tech stocks, and some of them may never quite trade below their historical averages for a long time. However, even if you’re prepared to pay a hefty premium, also make sure you’re getting ample enough earnings growth that is in line or at least close to the P/E you’re expected to shed out.

Well, Factset data implies that you’re unlikely to get good bang for your buck as the tech sector will likely deliver 17% earnings growth this year. In contrast, consider something like the healthcare sector that is poised to deliver 18% earnings growth, and can be picked up at a similar valuation threshold of 18.5x.

No matter what you think of them, sell-side brokerage reports can also be very influential in driving institutional flows to different pockets of the market. Note as things stand, the sell-side brethren are not expecting any meaningful upside in tech stocks, with the variance between their average target price and the current share price hovering at a miserly 6%, implying the lowest upside potential amongst all 11 sectors.

It’s also difficult for us to be too bullish about large-cap tech when its relative strength ratio versus the overall large-cap growth universe is currently at record highs and almost 25% higher than the mid-point of its long-term range. Now why are we emphasizing so much on tech? Well, this sector has an inordinate weight in SCHG, with almost 48% of its holdings coming from this sector alone.

Finally, we’ll close this piece with some thoughts on how unfavorable the reward to risk currently looks on SCHG’s own chart. Over the last 16 months, SCHG has been trending up in the shape of a tight ascending channel, and it would be prudent to respect the boundaries of this channel. As things stand, the ETF has just about hit the upper boundary of the channel and is almost on the cusp of trading above its upper Bollinger band which is 2 standard deviations away from the 20-period moving average (the red line).

All in all, we think the Schwab US Large-Cap Growth ETF is a fine vehicle to gain exposure to its focus universe, but we don’t believe this universe is a good bet at this juncture. SCHG is a HOLD.