The Information Technology sector ranks third out of the ten sectors as detailed in my Sector Rankings for ETFs and Mutual Funds report. It gets my Neutral rating, which is based on aggregation of ratings of 26 ETFs and 147 mutual funds in the Information Technology sector as of April 7, 2014. Prior reports on the best & worst ETFs and mutual funds in every sector are here.
Figures 1 and 2 show the five best and worst-rated ETFs and mutual funds in the sector. Not all Information Technology sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 24 to 412), which creates drastically different investment implications and ratings. The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst ETFs and mutual funds, which allocate too much value to Neutral-or-worse-rated stocks.
To identify the best and avoid the worst ETFs and mutual funds within the Information Technology sector, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings. My fund rating methodology is detailed here.
Investors should not buy any Information Technology ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.
Figure 1: ETFs with the Best & Worst Ratings – Top 5
Sources: New Constructs, LLC and company filings
Fidelity MSCI Information Technology Index ETF (FTEC) is excluded from Figure 1 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.
Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5
Sources: New Constructs, LLC and company filings
First Trust NASDAQ Technology Dividend Index Fund (TDIV) is my top-rated Information Technology ETF and Nationwide Mutual Funds: Nationwide Ziegler NYSE Arca Tech 100 Index Fund (NWJEX) is my top-rated Information Technology mutual fund. Both earn my Neutral rating.
PowerShares Dynamic Networking (PXQ) is my worst-rated Information Technology ETF and Rydex Series: Electronics Fund (RYELX) is my worst-rated Information Technology mutual fund. PXQ earns my Dangerous rating and RYELX earns my Very Dangerous rating.
Figure 3 shows that 63 out of the 592 stocks (over 25% of the market value) in Information Technology ETFs and mutual funds get an Attractive-or-better rating. However, 0 out of 26 Information Technology ETFs and 0 out of 147 Information Technology mutual funds get an Attractive-or-better rating.
The takeaways are: mutual fund managers allocate too much capital to low-quality stocks and Information Technology ETFs hold poor quality stocks.
Figure 3: Information Technology Sector Landscape For ETFs, Mutual Funds & Stocks
Investors need to tread carefully when considering Information Technology ETFs and mutual funds, as no ETFs and mutual funds in the Information Technology sector allocate enough value to Attractive-or-better-rated stocks to earn an Attractive rating. Investors should look at individual stocks for exposure to this sector.
International Business Machines Corp (IBM) is one of my favorite stocks held by TDIV and earns my Very Attractive rating. Over the past 11 years, IBM has grown after-tax profit (NOPAT) by 11% compounded annually and currently earns a top quintile return on invested capital (ROIC) of 15%. Also, IBM has generated positive economic earnings in 15 of the last 16 years. Despite all this, the stock remains undervalued. At the current price of ~$192/share it has a price to economic book value (PEBV) ratio of 1.0. This ratio implies the market expects IBM to not grow NOPAT by any meaningful amount for the remaining life of the company. IBM’s NOPAT did decline last year, but the company’s track record of innovation and profitability means investors would be foolish to bet against it adapting and returning to growth.
Applied Materials, Inc. (AMAT) is one of my least favorite stocks held by Information Technology ETFs and mutual funds and earns my Very Dangerous rating. Over the past nine years, AMAT’s NOPAT has declined by 8% compounded annually. The company’s ROIC is also much lower than it used to by, currently at 6%, down from an outstanding 23% just two years ago. The market seems to be bullish on a turnaround for AMAT though, as the stock is up 50% in the past year. To justify its current price of ~$20/share, AMAT would need to grow NOPAT by 11% compounded annually for the next 23 years. Even if AMAT executes on its turnaround, it’s hard to see much upside at this valuation.
415 stocks of the 3000+ I cover are classified as Information Technology stocks.
Figures 4 and 5 show the rating landscape of all Information Technology ETFs and mutual funds.
My Sector Rankings for ETFs and Mutual Funds report ranks all sectors and highlights those that offer the best investments.
Figure 4: Separating the Best ETFs From the Worst ETFs
Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds
Review my full list of ratings and rankings along with reports on all 26 ETFs and 147 mutual funds in the Information Technology sector.
Kyle Guske II contributed to this report.
Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.