FAST - IYM: Materials Dashboard For June

2023-06-19 07:29:00 ET

Summary

• The basic materials sector is close to 11-year averages regarding aggregate valuation metrics.
• Construction materials are the best-ranked subsector regarding value, quality, and momentum scores.
• IYM fast facts.
• One stock cheaper than its peers in June.

This monthly article series shows a dashboard with aggregate industry metrics in materials. It is also a review of sector ETFs like the Materials Select Sector SPDR ETF ( XLB ) and the iShares U.S. Basic Materials ETF ( IYM ), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italics 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 industry: 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 into 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 packaging in the table below is the 11-year average of the median Earnings Yield in packaging 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). In 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 industry (higher is better).

Evolution since last month

The value score has deteriorated in construction materials, which stay the best-ranked subsector though.

Momentum

The next chart plots momentum data.

Interpretation

The basic materials sector had a neutral value score when I published June's broad market dashboard . Construction materials are the best-ranked subsector regarding valuation, quality and also 12-month momentum. Packaging and chemicals are close to their historical baseline in valuation, and the former is above it in quality. The mining and metals industry is moderately overvalued, by about 12% relative to 11-year averages.

Fast facts on IYM

The iShares U.S. Basic Materials ETF started investing operations on 6/12/2000 and tracks the Russell 1000 Basic Materials RIC 22.5/45 Capped Gross Index. Its total expense ratio is higher than the sector benchmark ETF XLB: 0.39% vs.0.10%.

The fund has 39 holdings and it is very concentrated: the top 10 companies weigh 66.9% of asset value. The top name, Linde, weighs 22%.

Since 7/1/2000, IYM has underperformed XLB by 63 bps in annualized return, as reported in the next table. It also shows a higher risk measured in drawdown and volatility (standard deviation of monthly returns).

However, the funds are almost on par in 2023 to date:

In summary, IYM offers a capital-weighted exposure in basic materials companies of the Russell 1000 index. It currently holds 39 stocks including large and mid-caps, whereas XLB invests in 32 larger companies. IYM has a capped weighting methodology to avoid excessive concentration in top holdings (22.5% by company, 45% aggregate in companies weighting more than 4.5%). It is more expensive than XLB in management fees, and behind it in total return since 2000. Moreover, XLB is a better instrument for trading and tactical allocation, thanks to much higher trading volumes. Investors who are concerned by risks related to the top holding weight may prefer the Invesco S&P 500 Equal Weight Materials ETF (RSPM, formerly RTM ).

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 chemical company with an Earnings Yield above 0.0607 (or price/earnings below 16.47) is in the better half of the industry 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. For example, the company below was part of the list sent to subscribers several weeks ago based on data available at this time.

It is part of a rotational model with a statistical bias toward excess returns in the long term, not the result of in-depth stock analysis.

For further details see: