XNTK - XNTK: Technology Dashboard For September

2023-09-15 15:00:06 ET

Summary

• Technology is the second most overvalued sector now.
• However, semiconductors show a fair combination of value and quality scores.
• Focus on XNTK, an equal-weight technology ETF.
• 8 tech stocks were cheaper than their peers in September 2023.

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 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"), and 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 the last trading day'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 improved in software and semiconductors, and deteriorated in hardware and IT services.

Momentum

The next chart plots momentum scores based on median returns.

Interpretation

According to my S&P 500 monthly dashboard , technology is the second most overvalued sector after industrials. Hardware and electronic equipment are close to 11-year averages in valuation. However, my quality score is very bad for the former and fair for the latter. Communication equipment and semiconductors are moderately overvalued, which may be justified for the latter by a good quality score. Software and IT services are overvalued by about 30% relative to their historical baseline.

Fast Facts on XNTK

SPDR NYSE Technology ETF started investing operations on 9/25/2000 and tracks the NYSE Technology Index. It has 35 holdings and 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 37.6% of asset value, and the heaviest one weighs about 5.5%. Risks related to top holdings are much lower than for capital-weighted ETFs like XLK, where the top 2 names Apple Inc. ( AAPL ) and Microsoft Corp. ( MSFT ) represent 44.5% of asset value together.

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 ).

XNTK beats both XLK and RSPT in 2023 to date:

XNTK has an average daily trading volume of about $2M, whereas RSPT is at $14M. In summary, XNTK is an equal-weight technology ETF competing with RSPT. Long-term investors may prefer XNTK for its better performance in 10 years, and in 2023, whereas liquidity makes RSPT a better instrument for swing trading and tactical allocation.

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 0.0367 (or price/earnings below 27.25) 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 in the long term, not the result of an analysis of each stock.

For further details see: