SCHD: A Buffett-Style ETF For 2024 And Beyond (NYSEARCA:SCHD)

Introduction

It’s time to discuss one of my favorite ETFs on the market: the Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD).

My most recent article on the ETF was written on October 11, when I went with a comparison article titled “SCHD or SCHG? Buying Both Is The Way To Go.”

In this article, I want to highlight the ETF’s underperformance in 2023 and explain why I have high hopes for dividend equities in 2024 and beyond.

So, without further ado, let’s keep this intro short and get right to it!

What Happened To Dividends?

I did not outperform the market in 2023, and I’m not ashamed to admit it.

After all, my strategy is not to outperform the market every single year. That would require me to frequently adjust my holdings. As my favorite holding period is “forever,” that’s a no-go.

On a side note, Buffett’s Berkshire Hathaway (BRK.A) has returned 19.8% per year between 1965 and 2022. This performance has blown the stellar 9.9% annual return of the S&P 500 out of the water.

However, as we can see below, the company did not beat the market every single year.

Buffett is a long-term investor, which means he focuses on high-quality companies and buys these at a fair value.

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. – Warren Buffett

When done properly, investors are likely to beat the market if they focus on the right stocks, refrain from chasing hot stocks, and panic selling during corrections.

Going back to 1973, dividend growth stocks and dividend payers have been the best places to be – by a wide margin!

However, it’s not always a smooth ride.

Over the past twelve months, SCHD has returned 2.9%, including dividends. The S&P 500 returned 24% during this period!

In other words, most passive dividend-focused investors will have underperformed the market by a considerable margin.

This is not unusual.

Using the Vanguard High-Yield Dividend ETF (VYM) – because it has a longer history than SCHD – as an example, it had a similar performance as the S&P 500 between 2007 and 2017. After that, a steep decline in rates and inflation caused dividend stocks to underperform the market, as investors preferred high-growth tech stocks.

After a brief recovery in the VYM/SPY ratio, dividend stocks underperformed again in 2023.

On September 21, 2023, the Wall Street Journal wrote: “Dividend-paying stocks aren’t as attractive as they used to be.”

Higher Treasury yields compete for investors’ attention with dividend-paying stocks, with money managers arguing that it’s preferable to earn income by holding risk-free government bonds than stocks.

Furthermore, as we can see in the chart below, since the Great Financial Crisis, a very small part of the total return (capital gains + dividends) has come from dividends caused by low rates, lower inflation, and strong returns in low-yield sectors like technology.

Going forward, I expect that to change.

It’s Time For Dividends To Strike Back

In my 2024 Outlook, I highlighted the risks that come from an elevated valuation.

As we can see in the chart below, as of November 30, the S&P 500 was trading at “overvalued” levels. Only post-pandemic and Dot-Com levels were worse.

Whenever the market is overvalued, the future performance tends to be poorer, as we can see in the chart below.

Current valuation levels suggest a 5-6% annual return outlook for the S&P 500.

Furthermore, the S&P 500 has become very top-heavy.

As I discussed in my outlook, its top 10 holdings account for 32% of the index. Historically speaking, as soon as that number gets above 20%, the odds are that an equal-weight S&P 500 will outperform the market-weighted S&P 500.

In other words, this could very well become a stock-picking market!

However, investors do not need to pick single stocks if they don’t want to.

In order to beat the market, I believe it is enough to focus on a few key things:

• Buying stocks with strong balance sheets and wide-moat business models to withstand economic headwinds.
• Buying stocks with good valuations and/or decent yields, as we’ll likely see a rotation from growth to value, with a bigger part of total returns in the future coming from dividends.

When it comes to this market, where people chase growth stocks again, I believe the following quote hits the nail on the head:

For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments. – Warren Buffett

That’s where SCHD comes in.

With a 0.06% expense ratio, SCHD isn’t just a cheap ETF (cheap to hold), but it is also value-focused.

• 18% of its portfolio consists of industrial stocks.
• 17% of its holdings are healthcare investments.
• Financials account for 15% of its total exposure.
• Consumer staples have a 12.8% weighting.
• Information technology, the first non-value sector, accounts for just 12% of the ETF.
• Energy has a 10% weighting.

Its largest holdings are some of my favorite dividend (growth) stocks, including AbbVie (ABBV), Merck (MRK), Amgen (AMGN), Broadcom (AVGO), Home Depot (HD), and Texas Instruments (TXN).

Although I tend to stay away from ETFs, as I like to build my own portfolio, the SCHD holdings are exactly the stocks I’m watching to buy in 2024.

Furthermore, investors limit small-cap risks, as more than 69% of the ETF’s 104 holdings (adjusted for weight) have a market cap of more than $70 billion.

The turnover rate is just 26.6%, which means the ETF maintains a very passive investing strategy, which also helps to keep its expense ratio at just 0.06%.

Moreover, the ETF has a distribution yield of 3.6%, which is attractive, even for most income-focused investors.

Using Seeking Alpha numbers, the dividend has a five-year CAGR of 13.1%, beating the median ETF CAGR of 6.2% by a wide margin.

The three-year CAGR is a bit lower at 9.4%, which is still impressive. It also has a Seeking Alpha dividend quant score of A+.

In general, the ETF has some of the best quant scores on the market, scoring A-range scores for momentum, expenses, dividends, and liquidity.

While it is hard to guess future dividend growth, I expect the ETF to maintain long-term annual dividend growth in the 6-10% range, based on its biggest holdings and the fact that the economy isn’t as strong as it was a few years ago.

Based on these numbers, it is no surprise that SCHD has returned close to 350% since it went public in 2011.

Although the ETF failed to outperform the S&P 500, we need to be aware that this is due to a very poor performance in recent years when market participants mainly wanted growth stocks.

Going forward, I expect that to change.

Hence, I am buying value stocks (value/growth hybrids) with decent yields, good valuations, and business models that will hopefully allow me to hold these stocks for many decades to come – “Buffett style.”

As a result, I expect that SCHD will be a much more attractive investment than the S&P 500 in 2024 (and likely beyond).

Especially if the Federal Reserve communicates that it will cut rates slower than expected (the market has priced in no less than six cuts this year!), I expect a rotation from growth to value to occur.

This is likely to happen if core inflation remains above the 2% target for longer.

I also believe that we are close to the start of a rotation.

Furthermore, everything I said in this article is backed by the fact that the SCHD/SPY ratio is below its 2015 lows. Back then, cyclicals got slaughtered, leading to massive outperformance of tech stocks.

It is also close to its 2021 lows and just a bit above 2020 levels.

Again, if I weren’t a stock picker, I would be buying SCHD quite aggressively for my long-term dividend portfolio.

Takeaway

In a market dominated by growth stocks, the Schwab U.S. Dividend Equity ETF faced challenges in 2023, returning 2.9% against the S&P 500’s 24%.

However, history teaches us that dividend stocks, despite occasional underperformance, have been long-term winners.

As the market faces overvaluation and concentration risks, SCHD stands out with a value-focused approach and a diverse portfolio, offering stability and a 3.6% distribution yield.

Despite recent setbacks, the ETF’s impressive track record, strong fundamentals, and focus on quality stocks make it a compelling choice for investors seeking a “Buffett style” strategy in 2024 and beyond.