Buying an S&P 500 index fund today will net you a rather disappointing yield of just 1.3%. You can easily do better than that with individual stocks, but then you have to spend all of your time researching and tracking them.
A better option is an exchange-traded fund (ETF) — in this case, the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD), which basically does what you would do if you were buying individual dividend stocks. The best part is that its 3.7% yield is nearly three times what you would get from the S&P 500 today.
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What does the Schwab U.S. Dividend Equity ETF do?
There are a lot of different ways to slice and dice the market using dividends. The Schwab U.S. Dividend Equity ETF doesn’t just take one approach. It uses dividends in a couple of different ways.
The first cut in its selection process is to only consider companies that have increased their dividends annually for at least 10 years. That’s an effort to highlight financially strong and well-run companies.
It is a screen that many dividend investors use, too, when looking for stocks. Real estate investment trusts (REITs) are removed from consideration because they would likely dominate the resulting list.
Image source: Getty Images.
The next step for the Schwab U.S. Dividend Equity ETF is to create a composite score for each company still under consideration. The score includes cash flow to total debt, return on equity (ROE), dividend yield, and a company’s five-year dividend growth rate.
Cash flow to total debt and ROE examine financial strength and company quality, respectively, two things that dividend investors are likely to be interested in. Yield and the five-year dividend growth rate bring the payout back into the picture in different ways.
Using dividend yield in the composite score is simply a way to ensure that yield remains important. The five-year dividend growth rate, meanwhile, highlights both growing companies and ones that are rewarding investors well for sticking around. Again, these are two factors that dividend investors are likely to consider when buying individual stocks.
The 100 companies with the highest composite scores are put into the Schwab U.S. Dividend Equity’s portfolio. The stocks are market-cap weighted, so the largest companies have the largest impact on performance. And the cost for all of this work is a very modest 0.06% expense ratio.
What has the Schwab U.S. Dividend Equity achieved for investors?
The well-above market yield offered by the Schwab ETF has already been noted. But it is important to emphasize that investors are achieving their yield goals here with one simple investment. And the even more attractive piece of this story is that the ETF has increased in value over time while offering a very attractive yield. Both yield and capital growth will be attractive to just about every dividend investor.
SCHD data by YCharts.
That said, there’s one more positive to discuss, and it is the final piece that most dividend investors are looking for: the growth of the income stream it generates. The Schwab U.S. Dividend Equity delivers on that front, too, as the chart below highlights. Although the quarterly dividend varies from quarter to quarter, it has generally trended higher over time.
SCHD Dividend data by YCharts.
The growth of capital and the growth of the dividend actually go hand in hand. Essentially the growth of capital means there is more money to invest in dividend-paying stocks. So, when the portfolio is rebalanced annually, there is a very high likelihood that a new batch of companies with higher yields will end up in the portfolio. And that, over time, drives the dividend higher.
Don’t do the dividend work unless you want to
To be fair, the Schwab U.S. Dividend Equity ETF isn’t going to be fine-tuned to your specific needs. You might have to make some trade-offs to own it, including accepting a slightly lower yield than you may want.
But if you have $1,000, or $100,000, and are looking for a simple way to invest in attractive dividend stocks, this ETF is among the best options you are likely to find. After all, it is probably doing what you would do if you invested in individual dividend stocks.
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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.
