RHI - EXI: Industrials Dashboard For June

2023-06-16 10:52:05 ET

Summary

• Industrials is the second-most overvalued sector right now.
• However, one industry has good value and quality scores: transportation.
• iShares Global Industrials ETF is an alternative to Industrial Select Sector SPDR® Fund ETF with international diversification.
• 10 stocks cheaper than their peers in June.

This monthly article series shows a dashboard with aggregate subsector metrics in industrials. It is also a top-down analysis of sector ETFs like Industrial Select Sector SPDR® Fund ETF ( XLI ), whose largest holdings are used to calculate these metrics. This article will focus on iShares Global Industrials ETF ( EXI ), an exchange-traded fund ("ETF") with a high correlation to XLI and offering global exposure.

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each subsector : Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non-available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for transportation in the table below is the 11-year average of the median Earnings Yield in transportation companies. The Value Score ("VS") is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance.

Current Data

The next table shows the metrics and scores as of last week's closing. Columns stand for all the data named and defined above.

Value and Quality Chart

The next chart plots the Value and Quality Scores by subsector (higher is better).

Evolution Since Last Month

The most notable changes are a slight deterioration in valuation for aerospace/defense and building/construction equipment.

Momentum

The next chart plots momentum scores based on median returns.

Interpretation

Industrials are the second most overpriced sector in the U.S. stock market in June 2023 (read my article here ). However, the transportation industry is undervalued relative to 11-year averages and features a good quality score. Other subsectors are overvalued by 22% to 49% regarding the same metrics. Overvaluation may be partly justified by a good quality score for services/distribution. In aerospace/defense, both value and quality scores are significantly below the baseline.

EXI Fast Facts

iShares Global Industrials ETF started investing operations on 9/12/2006 and tracks the S&P Global 1200 Industrials IndexTM. It has 204 holdings, an expense ratio of 0.40% and a 12-month distribution yield of 1.51%. It is mostly invested and large and mega-cap (about 74% of asset value) and the portfolio turnover is low (7% in the most recent fiscal year). About 53% of assets is in U.S. companies. Therefore, we can expect some overlap and correlation with the U.S. sector benchmark, XLI.

The next table shows the top 10 holdings with fundamental ratios. Their aggregate weight is 20.9% of portfolio value. The largest one weighs about 2.4%, so risks related to individual companies are low. Eight of them are in the top holdings of XLI, which confirms the overlap. XLI is more concentrated, with over 4% in each of its top 5 holdings.

* These tickers are U.S. ADRs for convenience, the fund holds stocks in the primary exchange. Ratios by Portfolio123 .

Since 10/1/2006, EXI has lagged XLI by 2.2% in annualized return. Part of this underperformance is due to the dollar bullish trend since 2008 (currency risk). As expected, the correlation between the two funds is high: 0.96.

In summary, EXI has a lot in common with XLI regarding top holdings and price behavior. Therefore, iShares Global Industrials ETF may be an interesting alternative for investors seeing exposure to industrials with international diversification and a lower weight in top holdings.

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a transportation company with an Earnings Yield above 0.0616 (or price/earnings below 16.23) is in the better half of the subsector regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

It is a rotational model with a statistical bias toward excess returns on the long-term, not the result of an analysis of each stock.

For further details see: