Is Schwab U.S. Dividend Equity ETF Becoming a Crowded Trade That Smart Investors Should Avoid?

From a big-picture perspective, Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is a thematic investment focused on dividend-paying stocks. That, however, is very different from, say, a sector-focused exchange-traded fund. And it changes the equation when you consider the popularity of Schwab U.S. Dividend Equity ETF, which manages a huge $85 billion of assets.

What does Schwab U.S. Dividend Equity ETF do?

Schwab U.S. Dividend Equity ETF does not follow a specific sector or invest in a specific niche (such as artificial intelligence stocks). It uses fundamental screens to build a diversified portfolio that gets updated annually. The focus on dividends will bias the portfolio toward certain sectors and away from others, but the screening process dictates which assets get into the ETF.

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That allows the nature of Schwab U.S. Dividend Equity ETF to shift over time, making it an investment you can comfortably buy and hold for the long term. However, what is most important is that the screening process focuses on identifying high-quality companies likely to be resilient in the face of adversity.

The first step is to consider only companies with at least 10 years of annual dividend increases (REITs are excluded). After that point, a composite score is calculated for each company still under consideration. The score includes cash flow-to-total debt, return on equity, dividend yield, and a company's five-year dividend growth rate.

To summarize the screening process, Schwab U.S. Dividend Equity ETF is looking for strong, growing businesses and attractive, growing dividends. The 100 highest-ranked stocks get into the index using a market cap weighting approach, so the largest stocks have the biggest impact on performance.

Go ahead and join the crowd

There's really never a bad time to buy good dividend stocks, no matter how many other investors are buying this ETF. And given that the portfolio is updated annually, the portfolio will naturally shift out of stocks that have become expensive. Overpriced stocks usually have relatively modest yields, noting that yield is one of the metrics in the composite score.

That said, the real proof is in the results of Schwab U.S. Dividend Equity ETF. The value of the ETF has generally risen over time, and so, too, has its dividend. Don't be scared away by the very large size of this ETF; its fundamentally driven investment screens help ensure that it doesn't get caught up in the types of crowded investment fads that can lead to big losses for the last ones in the door.

Reuben Gregg Brewer has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.