SFY - SFY: Is This Zero-Fee Growth ETF Right For 2024?

2024-01-18 20:00:10 ET

Summary

• SFY is a well-diversified ETF holding 500 of the largest U.S. securities. Similar to SPY, it's outperformed since its inception, and routinely features a higher trailing and estimated growth rate.
• By incorporating a composite growth score into its weighting process, SFY has about 50% less exposure to Magnificent Seven stocks than most growth funds, including VUG, SCHG, and QQQ.
• However, I've downgraded SFY because its forward PEG ratio has increased from 1.35x to 2.45x in the last year, signaling that growth stocks are too richly valued.
• Still, SFY is not much riskier than SPY, and with no fees until at least June 2024, it remains a reasonable choice.

Investment Thesis

I last covered the SoFi Select 500 ETF ( SFY ) on December 15, 2022, framing it as a responsible way to re-enter growth stocks based on an attractive combination of growth and value. The result was positive, with SFY matching the 30% return of the SPDR S&P 500 Growth ETF ( SPYG ) in 2023 with substantially less exposure to Magnificent Seven stocks. In effect, SFY proved that strong returns with solid diversification were possible, and with a 0.00% net expense ratio, it remains a reasonable choice. However, there are signs that growth stocks are overvalued, and there might be better uses of capital than adding this fund to your portfolio. Below, I will update SFY's fundamentals, highlight what's changed in the last year, discuss how it's different from most plain-vanilla growth funds, and explain why I've decided to downgrade SFY to a "hold."

SFY Overview

Strategy Discussion

SFY is growth-oriented but typically has lower sales and earnings growth rates than most plain vanilla growth ETFs. Previously, I called it a "growth-light" fund, and I think that title is appropriate, given how its fundamentals consistently fall between SPYG and the SPDR S&P 500 ETF ( SPY ). That remains the case today, which I will highlight shortly.

The construction process starts with 3,000 of the largest U.S. equities by market cap. The largest 500 are selected (subject to a 20% buffer rule), and although market cap drives each stock's allocations, three growth-oriented factors drive adjustments that make SFY slightly different than SPY. The three factors are as follows:

1. Trailing one-year revenue growth
2. Trailing one-year earnings per share growth
3. Forward one-year earnings per share growth

It's a nice mixture of trailing and forward-looking metrics, but absent are long-term growth rates that might stabilize the Index and reduce turnover. Per the latest annual report , SFY's turnover rate was 17% for the year ending February 2023 and 16% for the six months ending August 2023. In contrast, SPY's turnover rate is consistently 2-4%, so it comes down to how much activity you want. SFY's turnover is still relatively low for a rules-based strategy, so it's not a deterrent for me.

Sector / Magnificent Seven Exposures

The following table lists sector exposures for SPY, SFY, and SPYG. Notably, despite being growth-oriented, SFY has less Technology exposure than SPY. The difference is a greater allocation to Consumer Discretionary and Energy.

With last month's reconstitution of S&P 500 Style Indexes, SPYG's top seven holdings are the Magnificent Seven stocks, as follows:

• Microsoft ( MSFT ): 13.49%
• Apple ( AAPL ): 12.48%
• Alphabet ( GOOGL ): 7.26%
• Amazon ( AMZN ): 6.48%
• Nvidia ( NVDA ): 6.48%
• Meta Platforms ( META ): 3.79%
• Tesla ( TSLA ): 2.83%

These stocks total 52.81%, so SPYG is a highly concentrated fund that I expect will produce substantially different returns than its value counterpart in 2024. In contrast, SFY's exposure to these seven stocks totals 26.29%:

• Microsoft (MSFT): 5.04%
• Apple (AAPL): 4.70%
• Alphabet (GOOGL): 2.94%
• Amazon (AMZN): 6.98%
• Nvidia (NVDA): 2.31%
• Meta Platforms (META): 1.11%
• Tesla (TSLA): 3.22%

With about 50% less exposure to Magnificent Seven stocks, SFY offers almost the same growth potential as SPYG but much better diversification. You'll also find similar concentration issues with other popular growth ETFs like VUG, SCHG, MGK, IWY, and, to a lesser extent, QQQ. You can click here for my October 2023 comparison of those five funds, but the main takeaway is that SFY's composition is positive if mega-cap stocks take a breather this year.

Performance Analysis

The following table highlights the total returns for SFY, SPY, and SPYG since May 2019. As expected, SFY fell between SPY and SPYG on nearly every metric listed, including standard deviation, best/worst years, and maximum drawdowns. The lone exception is the Sharpe Ratio, though all three are close.

This chart suggests that it's not reasonable to be against SFY without also being against SPY. In the same regard, you might also question SFY's purpose, as several other S&P 500 Index ETFs are available with much lower gross expense ratios, like IVV , VOO , and SPLG . However, SFY's differences are evident when evaluating it fundamentally, which I will do next.

SFY Fundamental Analysis

SFY's top 25 sub-industries total 70.90% of the fund, slightly more than SPY's 68.83% and much less than SPYG's 86.06%. I've already established that SFY is well-diversified, but the following table highlights how its 12.19% estimated EPS growth rate is closer to SPYG's than SPY's. That demonstrates the growth tilt SFY has featured since I began coverage.

I have three observations:

1. Growth estimates have decreased across the board since December 2022. At that time, SFY's estimated sales and EPS growth rates were 15.61% and 16.82%, but today, they're 10.79% and 12.19%. That's still about 1-3% better than SPY, but the gap was wider one year ago, and SFY traded at a similar forward earnings valuation (22.76x vs. 22.42x). Unfortunately, SFY is about two points more expensive, so overall, the growth/valuation advantage has deteriorated.

2. SFY is still the most attractive from a GARP perspective. When you divide the estimated EPS growth rate into its forward P/E, SFY's PEG ratio is 2.45 vs. 2.87 and 2.60 for SPY and SPYG, respectively. In December 2022, the PEG ratios for SFY, SPY, and SPYG were 1.35, 1.69, and 1.88, which I used as justification for my "buy" rating. That said, it's clear equities, and particularly growth equities, are richly valued, so a pullback this year seems reasonable.

3. SFY's quality, measured by the fund's 9.33/10 profit score, is sufficient. All sectors have double-digit net margins, and the fund's weighted average free cash flow margin is 16.10%, close to SPY's 17.03%. SPY is a higher-quality fund, but only marginally so because it emphasizes larger companies more.

Investment Recommendation

There's no reason to believe SFY will substantially trail or beat SPY over the long run. It's slightly outperformed since its inception, and although that is partially due to the expense ratio waiver, the latest annual report confirms the waiver is extended until at least June 30, 2024 . That gives investors a fee-free choice to tilt their portfolio toward growth with minimal additional risk and without significant exposure to Magnificent Seven stocks.

However, I'm not confident growth stocks are the way to go for 2024. SFY's forward PEG ratio increased from 1.35x to 2.45x over the last year, and it no longer trades at the same valuation as SPY. These are signs that growth stocks are overvalued, so taking some risk off the table is prudent. Therefore, I have changed my rating on SFY to a "hold," and I look forward to continuing the discussion in the comments below.

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