Home Trading ETFs SPYG, VOOG, And IVW: Gut Check Time For These Growth Fund

SPYG, VOOG, And IVW: Gut Check Time For These Growth Fund

by Vidya
Green arrow upward on stack of coins and growth graph on bokeh background

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Green arrow upward on stack of coins and growth graph on bokeh background

smshoot/iStock via Getty Images

Investment Thesis

The S&P 500 Growth Index provides exposure to large-cap growth stocks using three factors: sales growth, the ratio of earnings change to price, and momentum, and is most appropriate for long-term investors who are capable of withstanding an above-average level of volatility. Three ETFs track this Index that are virtually identical:

  1. SPDR S&P 500 Growth ETF (SPYG)
  2. Vanguard S&P 500 Growth ETF (VOOG)
  3. iShares S&P 500 Growth ETF (IVW)

The purpose of today’s article is to compare these ETFs against two other growth-oriented funds: the iShares Russell 1000 Growth ETF (IWF) and the Invesco S&P 500 Pure Growth ETF (RPG). I look to shed some light on each ETF’s valuation, growth, and earnings results and discuss how I expect them to fare in the short and long term. In the end, I find that VOOG, SPYG, and IVW are three efficient and cost-effective ETFs that should serve risk-tolerant investors well in the long run. However, the potential for significant price-multiple compression is real, and I recommend waiting for the dust to settle to get a better entry point.

ETF Overview

Strategy, Sector Exposures, and Top Holdings

As mentioned, SPYG, VOOG, and IVW all track the S&P 500 Growth Index, which is a subset of the S&P 500 after three growth factors are applied: three-year net change in earnings per share over current price, three-year sales per share growth rate, and 12-month percentage price change. At the same time, value scores are also computed based on book value to price, earnings to price, and sales to price ratios. The Growth Index is formed by selecting the top one-third of stocks with the highest growth score to value score ratio, plus a roughly equal portion of blended-style stocks. The graphic below illustrates at a high level how this works.

S&P 500 Growth and Value Style Baskets

S&P Dow Jones

The next image illustrates the similarities between the three ETFs and how they differ from IWF and RPG on assets under management, expenses, and sector exposures. Note that Vanguard’s product has an additional 60-65 holdings, but these have virtually no influence on the Index and have weightings rounded to 0.00%.

You can see that Technology stocks account for about 45% of the ETF, with Consumer Discretionary (17%), Communication Services (12%), and Health Care (10%) accounting for the majority of the remainder. IWF is similar, with even more exposure to the Technology and Consumer Discretionary sectors, but less in Communication Services and Healthcare. And finally, RPG is substantially different than all of them. I’ve included this fund in the analysis because even though the Pure Growth Index ETF has fewer holdings (55), it appears better diversified at the sector level and may be appealing to those not willing to go all-in on tech.

Morningstar Fund Comparison: SPYG, VOOG, IVW, IWF, and RPG

Morningstar Fund Comparison Tool

Apple (AAPL) and Microsoft (MSFT) are each fund’s major holdings, and the top ten stocks total 53.97%. The S&P 500 Growth Index is free-float market-cap weighted, so this significantly limits the influence of smaller companies. The next ten stocks add 10%, but for those not liking this level of concentration, IWF and RPG’s top 20 holdings total 59.08% and 48.15%, respectively. I’ll highlight this again in the fundamental analysis section later.

IVW Top Ten Holdings

iShares

Historical Performance

SPYG, VOOG, and IVW have returned an annualized 17.50% in the last ten years, with minor differences attributed to fund fees and other common sources of tracking error. The same is true for historical standard deviation and other risk measures like beta and the Sharpe Ratio.

Risk and Return Metrics for SPYG, VOOG, IVW, IWF, and RPG

Morningstar Fund Comparison Tool

IWF performed better, likely due to higher exposure to Technology stocks, while RPG underperformed by about 2% per year, possibly for the same reason. I don’t think either of these ETFs necessarily has an advantage in selecting the best growth stocks. Instead, sector exposure differences likely will drive returns like usual, so I wouldn’t rely on these results to make your selections. Technology could very well end up being an underperforming sector as we advance, and in that case, I’d expect an ETF like RPG to turn into the best performer.

ETF Analysis

The table below highlights key fundamental metrics for the three ETF’s top 20 constituents, showing that indeed, they hold very growth-oriented stocks. Only three have single-digit revenue growth estimates, and only two have single-digit EPS growth estimates for the following year. Many have grown their sales at a 20%+ rate over the last five years, and nearly all are highly profitable. This last point is why I don’t believe the warnings that a substantial crash is imminent. Yes, the valuations of growth stocks are probably too high, but these are the most profitable companies globally, so they warrant them to a certain degree. The potential for price-multiple compression is real and should be managed accordingly, but I believe these companies have a strong chance at bouncing back.

IVW, SPYG, VOOG Fundamental Metrics Including Beta, Market Capitalization, Revenue Growth, EPS Growth, Revenue Surprises, Price-Earnings Ratios, and Seeking Alpha Profitability Grades

Author Using Data From Seeking Alpha

As shown, the five-year beta of 1.12 suggests its holdings are slightly more volatile than the market, and its forward price-earnings ratio of 31.34 puts it about 5 points higher than the SPDR S&P 500 Index ETF (SPY). That’s the premium you’re paying for a growth-focused ETF. You could opt for RPG and its lower 29.54 forward P/E, but you’ll be buying into a less profitable and more volatile group of stocks with a higher expense ratio. For me, I’m most comfortable selecting IWF since I’d be willing to pay for a little less concentration in the top 20 (59.08% vs. 64.13%), but it’s all about getting the balance right. In my view, each option has its pros and cons.

Finally, I want to touch on the Q4 2021 earnings season, as I think it may impact your decision on how much to allocate to growth ETFs. Most S&P 500 Growth Index companies (80% of the Index weight) have reported this quarter and have averaged a revenue surprise of about 3%. This figure aligns with what Yardeni Research notes for the S&P 500 Index but is lower than before when price-earnings multiples were expanding. Also, earnings surprises reached 23.40% at the height of the pandemic but have since fallen to 5.80%, its longer-term average.

S&P 500 Revenue and EPS Surprises History

Author Using Data From Yardeni Research

While my preferred approach is to analyze an ETF’s fundamentals, I use this tracker to gauge sentiment in recognition that the market isn’t always rational. I see in this graph fading enthusiasm for stocks, which will likely negatively impact high P/E growth stocks. Furthermore, since the fall hasn’t stopped this earnings season, the bottom isn’t necessarily in yet.

Investment Recommendation

Most investors prefer either a value or a growth strategy, but I recommend staying flexible and letting fundamentals and market sentiment drive your decisions. Today, the S&P 500 Growth Index has a forward P/E ratio of 31.34, a 24.33% forward EPS growth rate, and A+ Profitability Ratings for each of its top ten holdings. The Index is of excellent quality, which is great for the long-term investor capable of managing a little extra volatility.

Short-term, however, there are headwinds. Revenue and earnings surprises are falling, putting high P/E stocks like Amazon (NASDAQ:AMZN) and Tesla (TSLA) most at risk. In addition, interest rate increases are likely over the next few months and could even be frontloaded if the St. Louis Federal Reserve Bank President has his way. There’s no telling how much of this news is priced into stocks yet, but I’m inclined to believe there will be many better entry prices for ETFs like SPYG, VOOG, and IVW. Before buying, I think investors should wait for signs that the downward trend is reversing – possibly as early as next quarter – and in the meantime, seek out similarly profitable stocks with lower P/E ratios in the value category.

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