META - XNTK: Technology Dashboard For June

2023-06-17 08:00:00 ET

Summary

• Electronic equipment and semiconductors show the best combination of value and quality scores.
• Software and IT services are overvalued by more than 30% relative to 11-year averages.
• Fast facts on SPDR® NYSE Technology ETF, an equal-weight technology ETF.
• 8 tech stocks cheaper than their peers in June.

This monthly article series shows a dashboard with aggregate industry metrics in information technology. It may also serve as a top-down analysis of sector ETFs like Technology Select Sector SPDR® Fund ETF (XLK) and SPDR® NYSE Technology ETF (XNTK), whose holdings are used to calculate these metrics.

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 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 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 hardware in the table below is the 11-year average of the median Earnings Yield in hardware 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 industry (higher is better).

Evolution Since Last Month

Hardware has greatly improved in both value and quality scores.

Momentum

The next chart plots momentum scores based on median returns.

Interpretation

According to my S&P 500 monthly dashboard , technology is the most overvalued sector. The best-looking subsector regarding my metrics is electronic equipment: it is close to the historical baseline in value score, and above it in quality. Semiconductors are overvalued by only 10% relative to 11-year averages, and it may be justified by a good quality score. Hardware has improved a lot in one month: valuation is now close to the baseline, but it suffers from a bad quality score. Other subsectors are overvalued by 27% to 31% regarding the same metrics.

Fast Facts on XNTK

SPDR NYSE Technology ETF started investing operations on 9/25/2000 and tracks the NYSE Technology Index. XNTK has an expense ratio of 0.35%, whereas capital-weighted ETFs in the same sector like XLK and VGT have a 0.10% fee.

As described by SSGA , the index is

composed of 35 leading U.S.-listed technology-related companies. (…) Stocks must also meet at least one of the following three revenue- and sales-based criteria: (i) have an increase in sales over the last twelve months, (ii) have only one consecutive quarter of negative sales growth over the last two years, or (iii) have revenue totals from the last four quarters that classify it within the top 75 companies within the specific industry classification (…) The Index is equal-weighted and rebalanced annually.

Positions are in equal weight after every annual rebalancing, but they may drift with price action. The next table shows the top 10 holdings now with their current weights and fundamental ratios. These are the constituents with the best momentum since the last rebalancing. Together, they represent 33.9% of asset value, and the heaviest one weighs about 5%. Risks related to top holdings are much lower than for capital weighted ETFs like XLK, where Apple Inc ( AAPL ) and Microsoft Corp ( MSFT ) together represent 46.6% of asset value as of writing.

Data calculated with Portfolio123.

In the last 10 years, XNTK has underperformed XLK, but it is shortly ahead of another equal-weight technology ETF: Invesco S&P 500 Equal Weight Technology ETF ( RSPT ).

However, it is the best performer in 2023 to date:

XNTK has an average daily trading volume of about 10K shares, whereas RSPT is at 85K with a more expensive share. In summary, XNTK is an equal-weight tech exchange-traded fund ("ETF") and a competitor to RSPT, but neither historical performance nor liquidity makes it very attractive.

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 hardware company with an earnings yield above 0.0406 (or price/earnings below 24.63) 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. 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: