PEJ ETF: A Pullback Might Provide A Buying Opportunity

Investment Thesis

According to Statista, global leisure tourism spending decreased by ~49% in 2020 compared to 2019. The tourism and leisure industries were therefore amongst the most affected sectors of the economy by lockdowns, and other social distancing measures triggered by the pandemic.

However, leisure and entertainment have since rebounded. For instance, revenue in the Travel & Tourism market is projected to reach $128,425m in 2022 according to Statista. Moreover, the sector is expected to show an annual growth rate (CAGR 2022-2026) of 9.80%, resulting in a projected market volume of $186,694m by 2026. The market’s largest segment is Hotels with a projected market volume of $78,215m in 2022. Moreover, it is expected that digitalization will play an increasing role in this sector. In the Travel & Tourism market, for instance, 70% of total revenue will be generated through online sales by 2026. In this article, I will review the Invesco Dynamic Leisure and Entertainment ETF (NYSEARCA:PEJ) which provides exposure to a basket of leaders in the Leisure and Entertainment business that are at the forefront of the industry’s digital transformation.

Strategy Details

The Invesco Dynamic Leisure and Entertainment ETF tracks the Dynamic Leisure & Entertainment Intellidex Index. The Index is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including price momentum, earnings momentum, quality, management action, and value. Moreover, the Index will invest into a basket of companies that are principally engaged in the design, production, or distribution of goods or services in the leisure and entertainment industries.

If you want to learn more about the strategy, please click here.

Portfolio Composition

From the sector allocation chart below, we can see the index places a high weight on Hotels, Restaurants & Leisure (representing around 52% of the index) followed by the Entertainment sector (representing around 20% of the index) and Media (accounting for ~12% of the index). PEJ is highly concentrated in cyclical industries such as travel and hospitality, which is what you would expect from a Leisure and Entertainment strategy. That said, I think it is important to see how that fits your sector diversification goals before purchasing this ETF.

In terms of geographical allocation, the fund invests exclusively in the United States.

PEJ invests over 27% of the funds into mid-cap value issuers, characterized as mid-sized companies where value characteristics predominate. Mid-cap issuers are defined as companies with a market capitalization between $2 billion and $8 billion. The second-largest allocation is large-cap growth equities. It is interesting to see that this ETF allocates more than 70% of the funds to small and mid-cap issuers, which generally have a longer runway to compound than large-cap issuers.

The fund is currently invested in 30 different stocks. The top ten holdings account for 46.54% of the portfolio, with no single stock weighting more than 6%. All in all, I would say that PEJ is pretty well-diversified across issuers.

Since we are dealing with equities, one important characteristic is the valuation of the portfolio. According to Invesco, the fund currently trades at an average price-to-book ratio of 4.80 and an average forward price-to-earnings ratio of 26.65. In addition to that, the portfolio has a return on equity of 39.35%. I generally consider a company trading at a forward price-to-earnings ratio above 20 to be richly valued. That being said, I think there are some exceptions where you can pay a premium for an outstanding business that delivers a high return on capital and has good growth prospects. In PEJ’s case, these companies have a very good return on equity on average (close to 39.35%).

Is This ETF Right for Me?

PEJ has a distribution rate of 0.65%. Given the low dividend yield, this ETF is not suitable for the dividend investor. I have compared below the price performance of PEJ against the price performance of the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) over 5 years to assess which one was a better investment. Over the five years, PEJ failed to outperform the S&P 500. In fact, the S&P 500 outperformed by a 78 percentage points margin. To put it into perspective, a $100 investment in PEJ five years ago would now be worth $110.31. This represents a CAGR of ~2%, which represents a mediocre absolute return, to say the least.

If we take a step back and look at the performance from a 10-year perspective, the results don’t change much. The S&P 500 finished once again on top, although it is interesting to see that PEJ was outperforming the market for a long period of time from 2013 up until 2019. The COVID-19 pandemic clearly didn’t help the industry and PEJ has since slowly recovered but the gap between SPY and PEJ is now much wider.

Key Takeaways

After a rough 2020, the Leisure and Entertainment industry is back and on track to post high single-digit growth rates until 2026. PEJ gives exposure to a basket of leading brands in this segment and provides good diversification across issuers. That said, Leisure and Entertainment stocks are very cyclical and sensible to the state of the economy. The rise of interest rates in the US is a clear risk in my opinion to the investment thesis and an economic slowdown will probably send most of the constituents’ stock prices much lower. Moreover, PEJ’s valuation doesn’t help. The ETF is trading at more than 25x forward earnings and is priced for perfection. Needless to say, I think the current valuation doesn’t leave any margin of safety.