QGRO - QGRO: New Index New Quality And Growth Opportunity

2023-12-12 01:58:16 ET

Summary

• QGRO's index changed effective May 31, 2023, and has held up reasonably well since against large/all-cap growth ETF alternatives like VUG, SCHG, and QQQ.
• With 10% allocated to Magnificent Seven stocks, QGRO can complement your portfolio in ways most broad-based growth ETFs can't. Its 22.15% estimated EPS growth rate is the third-best in its category.
• Managers keep track of allocations to "stable growth" and "high growth" companies, aiming to strike a reasonable balance between long-term viability and speculation. For Q3, the breakdown was 65/35.
• My analysis suggests that's fair enough, as QGRO's 9.21/10 profit score, while acceptable, is at my minimum. With quarterly reconstitutions, there will be many chances for managers to prove QGRO is truly a high-quality ETF.
• Despite this drawback, the positives should not be overlooked. QGRO is an exciting "buy" for long-term growth investors.

Investment Thesis

Effective May 31, 2023, the Index tracked by the American Century U.S. Quality Growth ETF ( QGRO ) changed, rendering its mediocre track record largely irrelevant. Therefore, I decided to evaluate QGRO based on its fundamentals alone, and so far, I like what I see. Offering superior sector diversification and growth potential compared to alternatives like the Vanguard Growth ETF ( VUG ), the Schwab U.S. Large-Cap Growth ETF ( SCHG ), and the Invesco QQQ ETF ( QQQ ), QGRO is built for the long-term growth investor. While I'm hesitant to add too much growth to my portfolio, given the uncertain economic environment, I've still assigned a buy rating to QGRO, and I look forward to explaining why in more detail below.

QGRO Overview

Strategy Discussion

QGRO tracks the American Century U.S. Quality Growth Index and is benchmarked against the Russell 1000 Growth Index. As summarized below, QGRO's expense ratio is 0.29%, has $713 million in assets under management, and only 25.48% of assets in its top ten. Crucially, Magnificent Seven stocks ( AAPL , MSFT , GOOGL , AMZN , NVDA , META , NFLX ) total 9.74% compared to 45.29%, 45.49%, and 42.88% for VUG, SCHG, and QQQ.

Rene Casis, an industry veteran with 25+ years of experience, leads the Portfolio Management Team. William Enderle serves as Associate Portfolio Manager with only six years of industry experience, four with American Century. The team takes a dynamic approach by selecting an appropriate combination of "stable" and "high growth" companies. For Q3, that allocation was 65% and 35%, according to this fund commentary .

Sector Exposures

The following table highlights sector exposures for QGRO. At the bottom, I've computed a "Sector Diversification Score," which scales each ETF's sector diversification against a perfectly diversified (e.g., equal weight by sector) and perfectly undiversified (e.g., single sector) benchmarks. QGRO's 5.12/10 score is not great, but it's better than 67% of all U.S. large/all-cap growth ETFs I track, including the three peers listed below.

At 39.94%, Technology is QGRO's largest exposure area. From a diversification perspective, the main negative is that it's nearly entirely Systems Software (16.77%) and Application Software (14.48%). Consumer Discretionary is a much better-diversified sector, with sub-industry allocations as follows:

• Hotels, Resorts & Cruise Lines: 4.59%
• Restaurants: 4.44%
• Apparel Retail: 4.34%
• Apparel, Accessories & Luxury Goods: 2.92%
• Footwear: 2.52%
• Homebuilding: 1.03%
• Other: 1.52%

QGRO also gets some growth potential from the Health Care sector, notably through Biotechnology stocks, which account for 4.47% of the portfolio. Led by Neurocrine Biosciences ( NBIX ), Incyte ( INCY ), and Alkermes ( ALKS ), these stocks have "A+" or "A-" Seeking Alpha Growth Grades and excellent sales and EBITDA growth rates. These are examples of the "high growth" companies QGRO selects, and although they may be present in market-cap-weighted ETFs, their allocations are negligible.

Performance

Briefly, I want to highlight QGRO's historical performance through November 2023. As shown in the table below, it could be better. Five-year total returns are 101.11% or 9-36% behind the three peers, and three-year total returns are 7-8% behind SCHG and QQQ.

However, most of this information is not helpful because of the May 31, 2023, Index change. Since then, QGRO has gained 13.60% compared to 14.13%, 14.61%, and 13.01% for VUG, SCHG, and QQQ, so it's held up reasonably well. As measured by standard deviation, risk was also lower, though low volatility is not typically a consideration for growth ETFs.

Fundamental Analysis

The following table highlights selected fundamental metrics for QGRO's top 25 holdings, totaling 50.63% of the portfolio. Notice the substantially smaller $206 million weighted average market cap figure, our first clue is that mega-cap stocks are less prominent than in VUG, SCHG, and QQQ. Smaller companies like Booking Holdings ( BKNG ) and ServiceNow ( NOW ) are at the top, each with excellent estimated sales and earnings per share growth rates.

Recall the 65/35 breakdown between stable and high-growth companies mentioned earlier for Q3. Without knowing the classification used, I get the same breakdown when using a 25% estimated EPS growth breakpoint. This puts BKNG, NOW, and NBIX in the "high growth category," while Alphabet and Microsoft are the stable growers.

Adding high-growth companies naturally improves the portfolio's estimated EBITDA and EPS growth rates - 19.01% and 22.15%, respectively, after limiting the influence of outliers to 50% (see table footnote). At 22.15%, QGRO's EPS growth is the third-highest large/all-cap growth ETF I track. Valuation is also reasonable, with QGRO trading at 32.28x forward earnings and 27.40x trailing cash flow. These valuations are in the same ballpark as VUG, SCHG, and QQQ, and from a GARP perspective, it's about as good as you could ask for. Even the Invesco S&P 500 GARP ETF ( SPGP ) offers an inferior combination (8.53% EPS growth, 17.38x forward P/E). Although SPGP's current composition implies investors should avoid growth stocks, QGRO offers stable exposure to the category. The Index rebalances monthly and reconstitutes quarterly.

Key Risk: Relatively Weak Profitability

Despite an ETF name that suggests high quality, QGRO's relatively weak 9.21/10 profit score is a key risk. This score, which is sector-adjusted, is about 0.40 0.50 points behind most market-cap-weighted growth funds and even below the 9.43/10 score for the SPDR S&P 500 ETF ( SPY ). Consider the supporting metrics below:

QGRO's weighted average gross profit margin is the best at 58.04%, but its net margins are about 5% lower, primarily due to lower allocations to Apple and Microsoft, which have 25.31% and 35.31% net margins, respectively.

I've analyzed hundreds of large-cap ETFs, and it's evident that highly profitable ETFs tend to have the strongest track records. The profit score where performance becomes negatively impacted is around 9.10-9.20/10. At 9.21/10, QGRO's score is barely acceptable, and the 65/35 breakdown offers about as much speculation as is appropriate for long-term investors. While it's comforting that managers pay attention to and report on the stable/high growth breakdown each quarter, QGRO's profit score is a metric I will pay close attention to as the holdings change. If there's a material drop, I will provide an update.

Investment Recommendation

I've rated QGRO a buy due to its superior diversification and growth potential over plain-vanilla growth ETFs like VUG, SCHG, and QQQ. Drawbacks include a virtually non-existent track record, a 31% allocation to software stocks, and a weak profit score relative to most large/all-cap growth ETFs. Still, QGRO is a reasonable way to diversify away from Magnificent Seven stocks, and it has an excellent chance of performing relatively well in 2024. Thank you for reading, and I look forward to the comments below.

For further details see: