A Neutral View On A Big Tech ETF


As of July 29, three of the top six components in the S&P 500 were members of the technology sector, the largest sector allocation in the benchmark U.S. equity index. In order, that trio is Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT) and Facebook Inc (NASDAQ:FB).

Tech Triumvirate

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Rising market values for big-name technology companies are, of course, a benefit to the plethora of cap-weighted technology sector exchange-traded funds on the market, including the Technology SPDR (ETF) (NYSE:XLK). XLK and rival technology ETFs have recently been seen printing all-time highs. In the case of XLK, that is particularly impressive when considering the ETF debuted in 1998, meaning it has already been through an infamous tech bubble.

XLK, the largest tech ETF by assets, allocates nearly 30 percent of its combined weight to Apple, Microsoft and Facebook. XLK is up 9.7 percent year-to-date, an advantage of 220 basis points over the S&P 500. That does not mean XLK's near-term upside is limited, but it is also does not mean analysts are fawning over the big tech ETF.

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For example, AltaVista Research rates XLK neutral, a rating that indicates that valuations adequately reflect the fundamentals of stocks in these funds, the research firm said. The majority of funds we cover fall into this category.

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Investor Sentiment And Action

Investors seem to agree with AltaVista's tepid assessment of XLK. Rather, investors have missed out on XLK's year-to-date bullishness as highlighted by the ETF's $1.9 billion in lost assets. Still, there are reasons to consider to XLK.

For example, the ETF possesses a trailing 12-month dividend yield, well above the yield on 10-year Treasurys. Additionally, XLK and comparable technology ETFs are home to companies that have some of the largest cash stockpiles in Corporate America, ensuring dividend growth trends for the sector should remain positive going forward.

Earnings growth has slowed for the Tech sector, and this year may stall altogether. But margins and ROE remain impressively high and the long-term EPS growth forecast still exceeds that for the S&P 500. Meanwhile the sector trades at a P/E discount to the S&P 500, whereas historically it has enjoyed a premium. As a result Tech's appreciation potential appears better than the S&P 500, though not enough to warrant an 'Overweight' recommendation, added AltaVista.

Of the nine original sector SPDR ETFs, XLK has the lowest percentage of its shares outstanding sold short at just 5 percent, according to AltaVista data.

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