SPYG Has A Long Runway Of Growth But Its Valuation Is Rich Already

ETF Overview

The SPDR Portfolio S&P 500 Growth ETF (SPYG) owns a portfolio of large and giant-cap growth stocks in the U.S. It tracks the S&P 500 Growth Index. The fund’s focus on growth stocks allow it to consistently outperform the S&P 500 Index in the past few years. These stocks also have better growth outlook than the broader market. Its high exposure to technology sector should allow it to benefit from several technological trends. However, stocks in its portfolio are trading at a much higher valuation than their historical averages. Therefore, we think investors may want to wait for a pullback.

Chart

Fund Analysis

Portfolio construction approach result in a portfolio of large-cap growth stocks

The S&P 500 Growth Index selects stocks in the S&P 500 Index that exhibits the strongest growth characteristics based on these three criteria: (1) sales growth, (2) earnings change to price, and (3) momentum. The index implements a market cap-weighted approach to select stocks that fit these three criteria. It basically relies on the market’s wisdom to determine the weightings of each stock in the index.

We like its market-cap-weighted approach as this results in a portfolio of large-cap or giant-cap stocks that have strong financial health status (see table below). These are also stocks that generate consistent cash flow from their services and products. For example, Apple (AAPL) has an ecosystem with multiple services (iTunes, cloud, etc.) that attract its customers to use its services. Once its customers started to use these services, it is difficult for them to switch. Therefore, Apple generates consistent cash flow from its services. Similarly, Microsoft (MSFT) runs a Software-as-a-Service business model that generates recurring revenues. Other companies such as Visa (V) and Mastercard (MA) also have networks of merchants that makes it difficult for their competitors to replicate. As a result, these companies can generate cash from each consumer’s transaction on their network.

Ticker

Stock Name

Morningstar Moat Rating

Financial Health Status

Weighting

MSFT

Microsoft

Wide

Strong

9.35%

AAPL

Apple

Narrow

Strong

8.91%

AMZN

Amazon

Wide

Strong

5.77%

FB

Facebook

Wide

Strong

3.40%

GOOGL

Alphabet Class A

Wide

Strong

2.95%

GOOG

Alphabet Class C

Wide

Strong

2.95%

V

Visa

Wide

Strong

2.31%

MA

Mastercard

Wide

Strong

1.93%

JPM

JP Morgan Chase

Wide

Strong

1.38%

HD

Home Depot

Wide

Strong

1.22%

TOTAL

40.17%

Source: Created by author

Many of the stocks in SPYG’s portfolio have long runway of growth

SPYG has a high exposure to technology stocks. In fact, technology stocks represent about 38% of its total portfolio. These stocks should benefit from several important technological trends. According to IDC, global information communication and technology spending is expected to reach over $6 trillion by 2022 (see chart below). IDC expects that these platforms such as cloud, mobile, social and big data will help drive growth in the next few years. Looking forward to longer term, stocks in SPYG’s portfolio should also benefit from several technology trends such as artificial intelligence, 5G, blockchain, virtual reality, etc.

Source: IDC Website

SPYG is trading at a premium valuation already

Below is a table that shows SPYG’s top 10 holdings. These top 10 holdings represent about 40% of its total portfolio. As can be seen from the table below, most of these stocks are trading at forward P/E ratios that are much higher than their 5-year averages. In fact, SPYG’s average weighted forward P/E ratio of 34.06x is much higher than their 5-year average P/E ratio of 30.31x.

Ticker

Stock Name

Forward P/E

5-Year P/E

Weighting

MSFT

Microsoft

32.89

22.07

9.35%

AAPL

Apple

23.42

14.49

8.91%

AMZN

Amazon

72.46

86.98

5.77%

FB

Facebook

23.31

27.07

3.40%

GOOGL

Alphabet Class A

27.32

22.66

2.95%

GOOG

Alphabet Class C

27.32

22.31

2.95%

V

Visa

33.44

26.34

2.31%

MA

Mastercard

36.50

27.64

1.93%

JPM

JP Morgan Chase

12.63

11.53

1.38%

HD

Home Depot

23.15

20.80

1.22%

TOTAL/WEIGHTED AVERAGE

34.06

30.31

40.17%

Source: Created by author

SPYG is also trading at a premium to the S&P 500 Index. As can be seen from the table below, its price to book and price to cash flow ratios of 5.41x and 15.86x are much higher than the S&P 500 Index’s ratios.

SPYG

S&P 500 Index

Price/Book

5.41x

3.03x

Price/Cash Flow

15.86x

11.84x

Sales Growth (%)

10.76%

6.93%

Cash Flow Growth (%)

11.83%

7.59%

Source: Created by author; Morningstar

Risks and Challenges

A shift from growth stocks to value stocks

As the name of the fund suggests, stocks in SPYG’s portfolio are generally considered growth stocks as these stocks typically enjoy much higher growth rates than the average of other stocks. In the past 10 years, the market sentiment has clearly favored growth stocks than value stocks. This has resulted in higher valuations for growth stocks and hence higher valuation for SPYG’s portfolio as demonstrated in our valuation analysis. On the other hand, value stocks have been trading at a deep discount. However, a reversal can happen anytime. According to a CNBC news, “value has been getting cheaper and cheaper. It’s gone from trading at about one-third the valuation multiples of growth stocks to roughly one-eighth the valuation multiple.” Therefore, if the market sentiment shifts from growth to value, we could see a contraction in SPYG’s valuation.

Investor Takeaway

We like SPYG’s portfolio of quality U.S. stocks and we see a long runway of growth for many of these stocks. However, stocks in SPYG’s portfolio are trading at expensive valuations than their historical averages. Therefore, we think a pullback will provide a better entry point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.


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