TMFC: Recalibrated Portfolio, The Same Overvaluation Problem (BATS:TMFC)

The previous time I covered the Motley Fool 100 ETF (BATS:TMFC), a large-cap fund featuring the stock picks from the Motley Fool analyst team, was in January 2022.

In the note, I arrived at a conclusion that TMFC’s past performance could instill confidence its strategy I called “hybrid active/passive” could yield decent results at times and the choppy start to 2022 might even look like an appealing entry point for growth-hungry investors, though also warned that the combination of factors it was most exposed to, namely concerning valuations partly because of the growth premia, made it a questionable investment for the higher interest rates era of 2022 and beyond, given the backdrop anything but supportive for lofty multiples.

Since the article was published on January 25, TMFC’s price has declined by approximately 3%, underperforming the S&P 500 by around 1.5%.

It did have a fairly successful March when it pared February losses, with a return marginally north of 5%, which was its best monthly result since October 2021 when it delivered around 8.3%.

However, this bout of bullishness did not last into April, contrarily, the price has been drifting lower almost incessantly this month. As of writing this article, the TMFC one-month price return is ~10.7%, even despite the fact that the strong earnings reported by Meta Platforms (FB) and Apple (AAPL), which together account for 17% of TMFC’s net assets, have recently catapulted their share prices (well, one more than the other).

Overall, since the beginning of the year, this mega-caps-focused fund has delivered a total return of ~15.8%, which is also well below the result of the iShares Core S&P 500 ETF (IVV) that has been propped up by pure-value stocks and thus fared far better.

Today, I would like to reassess the TMFC portfolio as it has been rebalanced and reconstituted in March in line with its quarterly schedule, thus it would be pertinent to address its updated holdings, current factor exposure, and check whether something has fundamentally changed and it has become worth considering at the current levels.

What has changed: new names, a few removals, shifts in factor exposure

I certainly would not say a tectonic shift has happened as just seven stocks were added (accounted for around 4% as of April 28) and six were removed (accounted for less than 1% in January).

More specifically, the following names were absent in the January version of the TMFC portfolio (weights as of April 28):

Regarding EMBC, it is worth noting that it is featured in the TMFC equity basket likely because it has been spun off from Becton, Dickinson (BDX), a healthcare equipment company, this April. TMFC was long BDX in January and remains long now, with a rather microscopic allocation of 0.4%. I suppose Embecta, technically a small-cap given ~$1.9 billion market capitalization, might be removed upon the next quarterly reconstitution.

Meanwhile, the following stocks can no longer be found in the portfolio:

The prosaic reason for Xilinx’s removal is its acquisition by AMD which was completed in February. Other names were sold likely because the Motley Fool analyst team is no longer bullish on them. It should be noted that their performance this year has been merely lackluster.

The top-ten cohort looks almost the same as in January, except for minor changes in stocks’ weights. Also, it should not go unnoticed that the top-heaviness and valuation issues have not gone anywhere; the key ten positions of TMFC now have ~59% weight vs. ~60.5% in January, though, for better context, since then the fund’s position in Apple has been trimmed from 424,899 shares to 402,662 and in Microsoft (MSFT) from 194,444 to 184,987 shares.

The overvaluation problem is perfectly illustrated by the respective Quant grades in the tables below.

Of course, the factors deserve much more attention. As share prices gyrate and companies report fresh results, also updating guidance, and analysts reassess future growth, the portfolio’s tilt towards one factor or another inevitably changes over time.

The problem of overvaluation I mentioned above means ~81% of the holdings have the Quant Valuation grades of D+ or worse (an improvement from ~89%), while only ~2.4% are relatively undervalued. This is even lower compared to January when around 6.3% of the fund’s net assets were parked in value stocks. It would be pertinent to note that Berkshire Hathaway (BRK.B) has (likely temporarily) dropped out of that league as its Valuation rating retreated to C, partly because its share price has been climbing higher this year as investors have been flocking to cheaper stocks that are nicely positioned for the high-inflation environment.

What surprised me a bit is that the share of stocks exhibiting growth characteristics almost halved, declining from over 34% to just around 18%. More specifically, the fund sold EPAM, ROKU, and DOCU that boasted robust growth prospects back in January, and this is certainly one of the reasons. At the same time, other companies, like Netflix (NFLX), have seen their ratings falling from the A and B (including + and -) levels.

To bring more color, I took a look at the revenue, EBITDA, and EPS growth rates as I did three months ago. It appears allocation to companies with no less than 20% 3-year revenue compound annual growth rates has declined marginally, from 38% to 35%. However, the share of those with 20% forward revenue growth rates has fallen to ~28% from ~38%. What was the culprit? Probably, higher financing costs are percolating into analysts’ forecasts; earnings tell a similar story, as the share of firms that sport over 20% Forward EPS growth rates has declined to ~54% from over 64%. Nevertheless, we do not see this trend impacting EBITDA forecasts since almost 60% of the holdings are anticipated to deliver at least 20% Forward EBITDA growth, an improvement from 53% in January.

Finally, exposure to the quality factor (assessed using the Quant Profitability grade) has become even larger, going from 96% to over 98%. The A league still has 93% of TMFC’s net assets. I should reiterate that this is consistent with the fund’s focus on large-size companies.

Final thoughts

Overall, the changes the portfolio has undergone are fairly minor, but even despite that, a rather material shift in exposure to some factors can be seen, especially in terms of growth, due to dynamics in share prices and changing pundits’ forecasts.

Optimists are once again attempting to reclaim abandoned positions as the heavyweight FAANGM growth players reporting their Q1 results. The example of FB, which has seen its stock price soaring following the earnings surprise, clearly illustrated that. But does that instill confidence growth can attempt a rematch, regardless of how aggressively the interest rates will be revised? Investors should answer by themselves whether they are content with premium multiples and growth stories that might stagnate amid scarcer capital (another way of saying, higher interest rates) or, though relatively unlikely for now, an outright recession and its repercussions. My today’s conclusion is that TMFC does not deserve an upgrade. It remains a Hold.