The S&P 500 index is near the highest levels in its history, pushing the index's dividend yield down to a paltry 1.2% or so. By contrast, the Schwab U.S. Dividend Equity ETF(NYSEMKT: SCHD) has a roughly 3.4% yield, making it a relatively attractive income option. But the really interesting part about this exchange-traded fund (ETF) is how it gets that yield.
Here is why this could be the smartest ETF to buy if you have $500 (or more) to invest right now.
Wall Street goes up and down
If you are a student of Wall Street history, you know that stocks can be very volatile at times. Often the worst downdrafts start from periods of extreme enthusiasm. Times when the stock market is hovering near record levels. That's pretty much the story of the market today, with the S&P 500 index at lofty levels and the index's dividend yield at historically low levels.
Image source: Getty Images.
In this environment, investors need to make sure they have a core portfolio of financially strong companies. If there is a bear market or a recession (or, worse, both!), the companies with the strongest finances will likely be the best able to survive the hit.
Although you can't eliminate the risk of a major market or economic correction, you can try to prepare for these outcomes. And if you are working with exchange-traded funds and not trying to cherry-pick stocks, then you want to lean toward funds with a quality focus. That's why dividend investors should be attracted to the Schwab U.S. Dividend Equity ETF right now, given its dual focus on income and quality.
What does the Schwab U.S. Dividend Equity ETF do?
The first cut for Schwab U.S. Dividend Equity ETF is dividend-related, since it only looks at companies that have increased their dividends for at least a decade. (Real estate investment trusts are not considered for the ETF.) However, even here, there's a quality angle, since only well-run companies tend to achieve that kind of dividend streak. So from the get-go, this fund is trying to eliminate stocks that have high yields because they may be risky to own.
The next step in the process is a bit more complex as it involves the Schwab U.S. Dividend Equity ETF creating a composite score. It's a little bit of a proprietary black box, but the ETF discloses that the score includes the cash-flow-to-debt ratio, return on equity, five-year dividend growth rate, and yield.
The first two are quality driven, with cash-flow-to-debt focused on balance sheet strength and return on equity looking at a company's management strength. Five-year dividend growth rate is sort of a combination of the two, and an extension of the 10-year streak, but really focuses on trying to highlight the strongest growing dividend stocks.
And yield is pretty basic. That part of the screen wants to make sure you get paid well to own the stocks in the ETF.
The top 100 stocks end up in the Schwab U.S. Dividend Equity ETF. They are weighted by market capitalization, ensuring that the largest companies have the largest impact on the fund's performance, which is how the S&P 500 index is weighted. You get all of this work done for a 0.06% expense ratio, which is a pretty modest price.
SCHD Total Return Price data by YCharts
As noted, the yield is a relatively attractive 3.4%. Yes, you can find higher-yielding ETFs, but they usually focus only on yield. Just buying the highest-yielding stocks inherently opens investors up to owning lower-quality companies. For investors who want to add in a hedge against broader market adversity, the Schwab U.S. Dividend Equity ETF is a far better bet.
An ETF that errs on the side of caution
If you look at the chart above, you'll probably notice that the S&P 500 index is handily beating the Schwab U.S. Dividend Equity ETF. However, the Schwab U.S. Dividend Equity ETF is basically tracking along with the equal weight version of the S&P 500 index. This is a sign of the risk in the broader market, since a small number of very large companies are driving the market cap weighted S&P higher right now.
In the current market environment, now is the time to appreciate the value of the quality screens that the Schwab U.S. Dividend Equity ETF uses to create its unique portfolio.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
