Key Points
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ETFs can be a great way to tilt your portfolio toward a certain market segment or industry.
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This Schwab ETF offers a better alternative than more traditional funds in its category.
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This factor is poised to outperform over the next decade based on analyst estimates.
- 10 stocks we like better than Schwab U.S. Dividend Equity ETF ›
When most investors think of ETFs, they think of broad-based index funds that track a benchmark like the S&P 500. While those are some of the most popular ETFs on the market, there’s a whole world of funds beyond them. You can buy an ETF that tracks just about any segment of the market, or even buy actively managed ETFs.
By investing in a specific market segment, you can tilt your portfolio toward a particular investment factor or industry. And one such factor that’s poised to outperform over the long run is value stocks.
But instead of buying a basic value stock ETF, another low-cost option looks like an even better opportunity. It’s produced a total return of 18% so far this year, while the S&P 500’s total return is just over 8%. And it could continue to outperform for years to come.
A value ETF by any other name
You might be surprised to learn that the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is actually one of the best value stock ETFs you can buy. While focused on stocks with a good track record of growing dividend payments and the financial wherewithal to keep paying increased dividends year after year, it actually uncovers and invests in some of the best value stocks in the market.
The ETF tracks the Dow Jones US Dividend 100 index, which means the portfolio manager doesn’t actually make any buy or sell decisions. That allows it to keep the expense ratio low at just 0.06%.
Inclusion in the index is based on weighing four factors for each stock in the investable universe of companies with at least 10 consecutive years of dividend payments: cash flow to debt, return on equity, dividend yield, and five-year dividend growth rate. Each company is ranked, and the top 100 are included in the index and remain there unless they fall out of the top 200 (to reduce turnover). Take a look at the top holdings in the fund:
As you might expect from companies with a good track record of paying dividends, these are all large, mature companies that produce predictable cash flows. The additional filters and the focus on just 100 total stocks ensure that the portfolio has a higher average quality than a standard value stock fund that uses pure valuation metrics to determine what constitutes value and includes the bottom half of a broad index.
For example, the Vanguard Value ETF holds over 300 stocks, and Micron Technology (the memory chip company) is the largest holding based purely on valuation, ignoring the cyclical nature of its industry.
Value is poised to outperform
While growth stocks have dominated the stock market for over a decade, the tides may be turning toward value. The Russell 1000 Value index has produced a total return of 17% so far this year, while its growth stock counterpart has returned just 4%. And the outperformance may be just getting started.
Historically, value stocks outperform growth stocks over the long run. But that outperformance shows up in bursts. In market downturns or choppier markets, value stocks shine. And while there’s no way to predict a market downturn, the current environment is well set up for value stocks.
Vanguard analysts update their capital markets model every quarter. Last quarter, the model estimated the 10-year return for U.S. value stocks would likely fall between 3.4% and 10.6% at the 25th and 75th percentiles. Compared with growth stocks, value stocks are projected to return between 1.8% and 9.1%. That’s to say, value stocks are poised to offer better upside with less downside.
There are some additional warning signs for growth investors, too. For example, analysts are projecting record-high long-term aggregate earnings growth for the S&P 500. In other words, growth expectations are very high, leaving more room for disappointment, which could lead to a rerating and a decline in stock prices. Value stocks are far more predictable than growth stocks, so they’re less likely to fall short of expectations.
Investors who want to tilt their portfolio toward the value factor should consider the Schwab U.S. Dividend Equity ETF.
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Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Abbott Laboratories, Amgen, Home Depot, Merck, Micron Technology, Texas Instruments, and Vanguard Value ETF. The Motley Fool recommends UnitedHealth Group and Verizon Communications. The Motley Fool has a disclosure policy.
