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ETF Of “High-Quality” Growth: Surprising Favorites

In terms of “what have you done for me lately” the tech sector’s reply is “not much.” Among six of the tech sector’s bellwether’s, only Google (GOOG) has managed to outpace the torrid 18.8% year-to-date rise of the S&P 500. Up until a week ago, Microsoft (MSFT) would have been an outperformer as well, but an 11% haircut after a disappointing earnings report killed that feel-good story. Apple (AAPL), Intel (INTC), Oracle (ORCL) and IBM (IBM) aren’t even in spitting distance.

GOOG Chart

GOOG data by YCharts

Yet all six are great candidates for further financial research if you happen to think investing in high quality companies with rock solid balance sheets matters. All six stocks jump to the head of the class when screening for three of the most telling quality metrics: return on equity, earnings consistency and low leverage.

Those six tech stocks are in the Top 10 holdings of the spanking new iShares MSCI USA Quality Factor ETF (QUAL). The ETF screens for large and midcap stocks with high ROE over the past year, low debt to equity and earnings stability measured as the variability (standard deviation) of year-over-year per share earnings for the past five fiscal years.

The new ETF is part of a growing lineup of iShares/MSCI theme-specific ETFs requested by institutional investors who want to be able to tactically adjust their portfolios to focus on certain market attributes, whether it be low volatility stocks, value stocks, size, or momentum. In back-testing, the MSCI World Quality index delivered a 12.7% annualized gain from late 1981 through this past May, compared to the 10.2% gain for the overall MSCI World index. The quality index also registered about 5% less risk.

As evidenced by the lagging performance of the aforementioned tech stocks this is not a strategy that outperforms when the market is on a tear. Rounding out the top 10 holdings are Exxon Mobil (XOM), Chevron (CVX), McDonald’s (MCD) and Home Depot (HD). Only Home Depot bests the S&P 500 year to date.

XOM Chart

XOM data by YCharts

That’s what makes them so intriguing. As market valuations have expanded over the past year, many of these lagging quality stocks give you an interesting two-fer: long-term balance sheet strength and current low valuations.

Yes, Apple is transitioning from growth stock to value stock, but at a 10.7 forward PE ratio, some financial research suggests you’re getting a whole lot of quality on the cheap.

AAPL Return on Equity Chart

AAPL Return on Equity data by YCharts

That falling ROE have you worried? Keep in mind that at 32% it is still double the ROE for Google. Moreover, while earnings per share has stopped its meteoric rise, we’re not looking at a cliff dive.

While natural gas continues to be the energy story with momentum, the big diversified energy companies -- and their dependence on oil -- have been off the radar. There’s no next-quarter argument for owning either Exxon Mobil or Chevron, but if you’re more patient, these quality standouts offer some interesting attributes. Using the YCharts Stock Screener, both rank in the top 5 of global integrated gas and oil companies for return on equity, with Exxon Mobil leading the pack.

And they’re in the top 5 for lowest debt to equity, as well.

In terms of earnings stability, both are among the few global big boys that have managed positive earnings growth over the past five years as oil prices have lagged along with slow economic growth.

For income investors, Chevron is also one of the 10 stocks from the top 50 holdings in the new quality ETF that has a current dividend yield above 3%. Freeport-McMoRan (FCX) is the top yielder with a 4.3% current payout. Intel follows at 3.95%. Pharma companies Eli Lilly (LLY) and Bristol-Meyers Squibb (BMY) have 3%+ current yields as do Kimberly-Clark (KMB), Clorox (CLX), Raytheon (RTN), McDonald’s and Sysco (SYY). Kimberly Clark, Clorox and McDonald’s all trade at above-market forward PE levels that have been rising throughout the year.

For a cheaper entry point for quality, among the ETF’s top 50 holdings, Marathon Petroleum (MPC), Phillips 66 (PSX) and Freeport-McMoRan all have sub 10 forward PE ratios.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  ETFs   tech stocks   

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