Sector Analysis 2Q16

The Materials sector ranks second out of the ten sectors as detailed in our 2Q16 Sector Ratings for ETFs and Mutual Funds report. Last quarter, the Materials sector ranked fourth. It gets our Neutral rating, which is based on aggregation of ratings of 10 ETFs and 11 mutual funds in the Materials sector as of April 18, 2016. See a recap of our 1Q16 Sector Ratings here.

Figure 1 ranks from best to worst the seven Materials ETFs that meet our liquidity standards and Figure 2 shows the five best and worst rated Materials mutual funds. Not all Materials sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 24 to 121). This variation creates drastically different investment implications and, therefore, ratings.

Investors seeking exposure to the Materials sector should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.

Figure 1: ETFs with the Best & Worst Ratings – Top 5


* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Fidelity MSCI Materials Index (FMAT), First Trust Materials AlphaDex Fund (FZX), and Guggenheim S&P 500 Equal Weight Materials (RTM) are excluded from Figure 1 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums.

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5


* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Vanguard Materials Index Fund (VAW) is the top-rated Materials ETF and Fidelity Advisor Materials Fund (FMFEX) is the top-rated Materials mutual fund. VAW earns an Attractive rating and FMFEX earns a Neutral rating.

SPDR S&P Metals & Mining ETF (XME) is the worst rated Materials ETF and Rydex Series Basic Materials Fund (RYBMX) is the worst rated Materials mutual fund. XME earns a Dangerous rating and RYBMX earns a Very Dangerous rating.

162 stocks of the 3000+ we cover are classified as Materials stocks.

Westlake Chemical Corp (WLK: $47/share) is one of our favorite stocks held by Materials ETFs and mutual funds and earns a Very Attractive rating. Over the past five years, Westlake has grown after-tax profits (NOPAT) by 22% compounded annually. Over the same time period, WLK’s NOPAT margins increased from 8% to 15%. The company’s return on invested capital (ROIC) has improved from 8% in 2010 to a top-quintile 15% in 2015. Despite the profit growth, WLK is down 28% over the past two years, which has left shares undervalued. At its current price of $47/share, Westlake has a price-to-economic book value (PEBV) ratio of 0.9. This ratio means that the market expects Westlake’s NOPAT to permanently decline by 10% from its current level. If WLK can grow NOPAT by just 6% compounded annually for the next five years, the stock is worth $70/share today – a 49% upside.

Steel Dynamics (STLD: $24/share) is one of our least favorite stocks held by XME and earns a Dangerous rating. Over the past decade, Steel Dynamic’s NOPAT has declined by 1% compounded annually. More alarming, the company’s ROIC has fallen from 16% in 2005 to a bottom-quintile 4% in 2015. Steel Dynamics has failed to generate positive economic earnings in any of the past seven years, which further highlights the deterioration of the business. However, STLD remains overvalued, and market expectations are too high. To justify its current price of $24/share, Steel Dynamics must grow NOPAT by 16% compounded annually for the next 16 years. Given the decline in profits over the past decade, this expectation seems overly optimistic.

Figures 3 and 4 show the rating landscape of all Materials ETFs and mutual funds.

Figure 3: Separating the Best ETFs From the Worst ETFs


Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds


Sources: New Constructs, LLC and company filings

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.

Click here to download a PDF of this report.

Photo Credit: AgriLife Today (Flickr)

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