Summary
- All technology industries are overvalued relative to 11-year averages.
- Semiconductors still look quite attractive, thanks to a good quality score.
- Fast facts on RYT, an equal-weight technology ETF.
- 6 stocks cheaper than their peers in February 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 the Technology Select Sector SPDR ETF ( XLK ) and the Invesco S&P 500 Equal Weight Technology ETF ( RYT ), 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.
VS | QS | EY | SY | FY | ROE | GM | EYh | SYh | FYh | ROEh | GMh | RetM | RetY | |
Hardware | -18.46 | -42.29 | 0.0204 | 1.2334 | 0.0233 | 1.73 | 38.05 | 0.0362 | 0.9486 | 0.0400 | 7.16 | 41.70 | 11.05% | -19.14% |
Comm. Equip. | -33.85 | -16.59 | 0.0207 | 0.3273 | 0.0059 | 13.59 | 51.54 | 0.0314 | 0.2774 | 0.0406 | 15.87 | 63.50 | -1.98% | -7.05% |
Electronic Equip. | -23.62 | 22.16 | 0.0390 | 0.6026 | 0.0249 | 17.65 | 38.80 | 0.0428 | 0.8004 | 0.0397 | 13.01 | 35.69 | 5.32% | 1.81% |
Software | -28.43 | -4.47 | 0.0218 | 0.1134 | 0.0245 | 16.96 | 82.11 | 0.0266 | 0.1718 | 0.0367 | 17.75 | 85.99 | 9.40% | -22.04% |
Semiconductors | -6.91 | 17.88 | 0.0537 | 0.2039 | 0.0281 | 32.13 | 62.67 | 0.0463 | 0.2450 | 0.0351 | 23.78 | 62.24 | 8.81% | -11.06% |
IT Services | -24.60 | -0.11 | 0.0342 | 0.2118 | 0.0237 | 28.04 | 50.77 | 0.0384 | 0.3265 | 0.0328 | 25.98 | 55.28 | 4.02% | -9.78% |
Value And Quality chart
The next chart plots the Value and Quality Scores by industry (higher is better).
Evolution since last month
Hardware has significantly deteriorated regarding both valuation and quality. The quality score has deteriorated in communication equipment, IT services, and so did the value score in semiconductors.
Momentum
The next chart plots momentum data.
Interpretation
Technology industries are overvalued by 7% to 34% relative to 11-year averages. It may be justified by a good quality score in semiconductors, and to a lesser extent in electronic equipment. Hardware, which has been the most attractive tech industry for months, shows a serious deterioration in valuation and quality.
Fast facts on RYT
The Invesco S&P 500 Equal Weight Technology ETF has been tracking the S&P 500 Equal Weight Information Technology Index since 11/01/2006. It has a total expense ratio of 0.40%, whereas capital-weighted ETFs in the same sector like XLK and VGT have just a 0.10% fee. As of writing, the fund holds 76 stocks. Constituents are in equal weight after every rebalancing. The next table shows the top 10 holdings with their current weights and some basic ratios. These are the stock with the best momentum since the last rebalancing. Together, they represent 15.2% of asset value. Risks related to top holdings is much lower than for capital weighted ETFs, where Apple Inc. ( AAPL ) and Microsoft Corp. ( MSFT ) together represent over 40% of asset value.
Ticker | Name | Weight% | EPS growth %TTM | P/E TTM | P/E fwd | Yield% |
Seagate Technology Holdings plc | 1.60 | -64.72 | 25.40 | 46.21 | 3.93 | |
Salesforce, Inc. | 1.59 | -84.70 | 616.50 | 34.68 | 0 | |
Monolithic Power Systems, Inc. | 1.58 | 79.10 | 55.43 | 38.05 | 0.80 | |
Nvidia Corp. | 1.56 | -27.50 | 92.69 | 66.67 | 0.07 | |
Skyworks Solutions, Inc. | 1.55 | -12.04 | 16.50 | 12.91 | 2.05 | |
Zebra Technologies Corp. | 1.54 | -44.14 | 36.41 | 18.41 | 0 | |
Advanced Micro Devices, Inc. | 1.47 | -65.74 | 94.26 | 26.81 | 0 | |
Western Digital Corp. | 1.46 | -104.62 | N/A | N/A | 0 | |
ON Semiconductor Corp. | 1.45 | 86.61 | 19.87 | 19.01 | 0 | |
Ceridian HCM Holding, Inc. | 1.44 | 4.55 | N/A | 62.29 | 0 |
Data calculated with Portfolio123
RYT has underperformed XLK since November 2006, with a total return of 541% vs. 726% for the capital-weighted fund. The difference in annualized return is about 1.6 percentage point. Despite a lower idiosyncratic risk (exposure to individual stocks), RYT shows a higher historical volatility and a deeper maximum drawdown.
Total Return | Annual Return | Drawdown | Sharpe | Volatility | |
RYT | 525.45% | 11.93% | -58.91% | 0.6 | 20.79% |
XLK | 683.46% | 13.49% | -53.04% | 0.71 | 18.67% |
In summary, RYT is a good instrument for investors seeking a technology fund without excessive exposure to big tech companies. However, the theoretical edge of the equal-weight methodology has been disappointing in this sector for 16 years. Moreover, management fees are higher.
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 0.0204 (or price/earnings below 49.01) 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.
Kulicke & Soffa Industries, Inc. | |
Thryv Holdings, Inc. | |
Synaptics, Inc. | |
NXP Semiconductors N.V. | |
Alpha and Omega Semiconductor Ltd. | |
Gen Digital Inc. |
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:
RYT: Technology Dashboard For February