XOM - MGC: Vanguard's Cost-Efficient ETF For Mega-Cap Blue-Chip Exposure

2023-03-21 14:09:34 ET

Summary

• Vanguard Mega Cap ETF has an expense ratio of only 0.07%. As such, it's a great way for investors to gain diversified exposure to America's largest blue-chip companies.
• The MGC ETF has a 10-year average annual return of 12.3% and with $3.7 billion in assets is a very liquid fund.
• This ETF is currently most highly exposed to the technology, healthcare, and consumer discretionary sectors.
• Top holdings include Apple, Microsoft, Amazon, Tesla, Nvidia, Google, and Berkshire Hathaway.

The Vanguard Mega Cap ETF ( MGC ) is a very cost-efficient (0.07% fee) way for investors to gain well-diversified exposure to America's biggest, best, and cash-rich blue-chip companies. This fund's strong long-term performance track record (10-year average annual returns of 12.3%) indicate it could be considered as a core long-term holding in a well-diversified portfolio. Let's take a closer look.

Investment Thesis

In the current macroeconomic environment, which includes bank collapses, high inflation, rising interest rates, and Russia's still raging war on Ukraine that broke the global food and energy supply chains, investing in some of America's biggest and best blue-chip companies makes a lot of sense. Most of these companies are cash rich, generate tons of free cash flow, and have powerful global brands. That being the case, today I will dig down on Vanguard's Mega Cap ETF and show why it's one of the most cost-efficient ways for investors to gain exposure to these excellent blue-chip companies.

Top-10 Holdings

The top-10 holdings in the MGC ETF are shown below and were taken directly from Vanguard's MGC ETF webpage , where you can get more detailed information on the fund:

The fund holds roughly half the number of companies (232) as compared to the S&P 500 and the top-10 holdings equate to what I consider to be a well-diversified 30% of the entire portfolio. That said, the relatively large weights in Apple ( AAPL ) and Microsoft ( MSFT ) indicate that investors who already have full positions in these two companies might look elsewhere from a diversification perspective.

The #1 holding is Apple, with a 7.9% weight. Apple is well covered on Seeking Alpha, so I won't go into details other to point out that the company ended Q1 FY23 with $30 billion in cash - and that was after returning $25 billion to shareholders during the quarter. Apple stock is +26.2% YTD as a result of what some (myself included ...) might argue has been a flight-to-quality.

Microsoft is the #2 holding with a 6.6% weight. Similar to Apple, Microsoft also is cash rich, ending its Q2 FY23 (calendar Q4) with $99.5 billion in cash and cash equivalents. Based on 7.47 billion shares outstanding, that equates to an estimated $13.32/share. Microsoft Cloud revenue gained 22% yoy (26% on a constant currency basis).

Amazon ( AMZN ) is the #3 holding with a 2.9% weight. Amazon has been struggling to raise efficiency and to downsize its employee base after a huge hiring boom during the pandemic. The stock is down nearly 40% over the past year, but over the past few months the chart shows signs of bottoming:

The #4 holding is Tesla ( TSLA ) with a 2.0% weight. Despite nearly doubling from its "Twitter induced low" around $100, TSLA stock is still down 40% over the past year - that despite what I would argue have been relatively strong operational and financial performances. The following slide from the Q4 FY22 Presentation demonstrates the company's operational performance:

As can be seen, total EV deliveries were +31% yoy, driven by a 46% increase in Model S/X deliveries. Solar Storage during the quarter grew to 2.46 GW, up 152% yoy while Supercharger Stations grew by 35% yoy.

Counting both classes of Google stock - A & C, or ( GOOGL ) and ( GOOG ), respectively, in aggregate parent company Alphabet, equates to a 3.6% weight in the MGC ETF and is therefore - in effect - the third-largest holding in the fund. GOOG continues to be my favorite mega-tech company due to its strong free cash flow profile, its huge cash position, its excellent global position and branding in search and video, and for its vastly under-valued "other" categories like AI and autonomous driving.

Here's what I mean and what I like so much: Google ended Q4 FY22 with a whopping $139.6 billion in cash and cash equivalents (or an estimated $10.37/share). Google Cloud ("GCP") revenue grew 32% yoy to $7.3 billion. Free cash flow generation in Q4, despite all the hand-wringing about search, was $16 billion, or 21% of Q4 revenue ($76 billion).

The combination of Berkshire Hathaway ( BRK.A ) and Exxon Mobil ( XOM ), the #7 and #9 holdings, means that MGC has a strong position in oil and gas. I say that because, as you know, Berkshire holds big stakes in both Chevron ( CVX ) and Occidental Petroleum ( OXY ). As of the most recent filing , those stakes equated to $29.3 billion in Chevron and $12.5 billion in OXY. Of course, the largest holding in Berkshire's portfolio is - by far - Apple (38.9% of the total).

From a top-level allocation perspective, the MGC ETF is most highly exposed to the Technology, Health-Care, and Consumer Discretionary sectors:

Performance

As mentioned earlier, the MGC ETF has a strong 10-year performance track record with an average annual total return of 12.3%:

Note also that the pre- and post-pandemic performances (i.e., 5-year and 3-year) were quite strong as well.

The following graphic compares the MGC ETF's five-year total returns performance against some of its peers (or "near peers"): The Vanguard Mega Cap Growth ETF ( MGK ), the Vanguard Mega Cap Value ETF ( MGV ), the Fidelity Large Cap Stock Fund ( FLCSX ), and Invesco S&P 500 Top 50 ETF ( XLG ), and the SPDR DJIA ETF ( DIA ):

As can be seen, the MGC ETF lands in the middle of the pack and returned ~13% less than the MGK ETF - the winner of this group of ETFs. Still, MGC delivered a solid performance - outperforming the DJIA by 15%-plus.

Risks

The MGC ETF is not immune to the macroeconomic headwinds currently facing the U.S. and global economies: High inflation, rising interest rates, and slowing global growth - much of that having to do with Russia's war on Ukraine which arguably broke the global food and energy supplies chains just as most of the planet started to recover from the global pandemic.

Also, many of the companies in the MGC ETF have excellent global brands. With that comes exposure to foreign currency headwinds if the U.S. dollar is strong (as it was in 2022). The other side of that coin is that if the U.S. dollar begins to weaken, that would be a strong tailwind for this fund.

Summary and Conclusion

I like the MGC ETF because it has excellent exposure to the best American companies, which are the best companies on the planet. These companies typically have large cash positions, A-rated balance sheets, and have - in the main - continued to generate strong free cash flow despite the global economic headwinds. Investors looking for a very cost-efficient way to have exposure to these great American companies should BUY the MGC ETF. That said, and given a nod to market volatility, I wouldn't go "all-in" with a single purchase, but instead advise dollar cost averaging into the fund over time and build up your position relatively slowly.

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