Vanguard S&P 500 Growth ETF Is Now Undervalued But Visibility Is Still Limited – Vanguard S&P 500 Growth ETF (NYSEARCA:VOOG)

ETF Overview

The Vanguard S&P 500 Growth ETF (VOOG) owns a portfolio of U.S. large-cap growth stocks. The fund seeks to track the investment results of the S&P 500 Growth Index. VUG has a high exposure to technology stocks and has a portfolio of stocks with growth momentum. These stocks are now trading at valuations below their historical averages. However, given the current economic uncertainty due to COVID-19, downside risk remains. Therefore, we think investors should wait on the sidelines.

Data by YCharts

Fund Analysis

Portfolio construction approach result in a portfolio of large-cap growth stocks

The S&P 500 Growth Index selects stocks in the S&P 500 Index that exhibit the strongest growth characteristics based on these three criteria: (1) sales growth, (2) earnings change to price, and (3) momentum. The index implements a market cap-weighted approach to select stocks that fit these three criteria. It basically relies on the market’s wisdom to determine the weightings of each stock in the index.

We like its market-cap-weighted approach as most of its stocks are large-cap stocks that have strong financial health status as they generate consistent cash flow from their services and products. For example, Apple (AAPL) has an ecosystem with multiple services (iTunes, cloud, etc.) that attract its customers to use its services. Once its customers start to use these services, it become quite difficult for them to switch. Therefore, Apple generates consistent cash flow from its services. Similarly, Microsoft (MSFT) runs a Software-as-a-Service business model. Other companies such as Visa (V) and Mastercard (MA) also have networks of merchants that make it difficult for their competitors to replicate.

Ticker

Stock Name

Morningstar Moat Rating

Financial Health Status

Weighting

MSFT

Microsoft

Wide

Strong

9.2%

AAPL

Apple

Narrow

Strong

8.5%

GOOGL

Alphabet

Wide

Strong

6.0%

AMZN

Amazon

Wide

Strong

5.8%

FB

Facebook

Wide

Strong

3.4%

V

Visa

Wide

Strong

2.3%

MA

Mastercard

Wide

Strong

1.9%

JPM

JPMorgan Chase

Wide

Strong

1.3%

HD

Home Depot

Wide

Strong

1.3%

ADBE

Adobe

Wide

Moderate

1.2%

TOTAL

40.9%

Source: Created by author

High exposure to technology stocks

VOOG has a high exposure to technology sector. As can be seen from the table below, information technology stocks represent nearly 38% of its total portfolio.

Source: Vanguard Website

We like VOOG’s exposure to technology stocks. These stocks should benefit from several important secular growth trends such as digitization, cloud services, etc. According to IDC, worldwide spending on the technologies and services that enable the digital transformation of business practices, products, and organizations is forecast to reach $2.3 trillion in 2023. Digital transformation spending is expected to steadily expand throughout the 2019-2023 forecast period. IDC’s research suggest that the five-year compound annual growth rate will be over 17%. This will allow a long runway of growth for technology companies in VOOG’s portfolio.

VOOG appears to be undervalued now

Below is a table that shows VOOG’s top 10 holdings. These top 10 holdings represent nearly 41% of its total portfolio. As can be seen from the table below, VOOG’s average weighted forward P/E ratio of 25.67x is now much lower than their 5-year average P/E ratio of 30.46x. In fact, 9 out of 10 stocks are trading at forward P/E ratios below their 5-year averages. Therefore, we think VOOG is now undervalued. However, investors should keep in mind that if the outbreak of COVID-19 cannot be contained quickly and lasts for more than several quarters, many of these companies in VOOG’s portfolio may be forced to revise their future earnings forecast downward. This will impact VOOG’s fund performance.

Ticker

Stock Name

Forward P/E

5-Year P/E

Weighting

MSFT

Microsoft

21.93

22.12

9.2%

AAPL

Apple

17.06

14.50

8.5%

GOOGL

Alphabet

19.80

22.65

6.0%

AMZN

Amazon

62.50

86.23

5.8%

FB

Facebook

16.39

26.78

3.4%

V

Visa

24.27

26.31

2.3%

MA

Mastercard

23.81

27.61

1.9%

JPM

JPMorgan Chase

7.88

11.47

1.3%

HD

Home Depot

14.45

20.64

1.3%

ADBE

Adobe

29.94

31.14

1.2%

TOTAL/WEIGHTED AVERAGE

25.67

30.46

40.9%

Source: Created by author

Risks and Challenges

An economic recession

Investors should keep in mind that an economic recession will likely result in a significant decline in earnings for stocks in VOOG’s portfolio. For example, in an economic downturn, many companies will dramatically cut their marketing expenses. This will result in lower advertising revenue for Google (GOOGL) (NASDAQ:GOOG) and Facebook (FB). Similarly, companies such as Visa and Mastercard will experience declining revenues due to lower consumer and business spending.

Investor Takeaway

VOOG provides a good vehicle to invest in large-cap growth stocks in the S&P 500 Index. These stocks generally outperform the broader market due to their growth momentum. However, these stocks are not immune to an economic downturn. Although they are trading at valuations below their historical averages, investors may want to be careful as many companies may revise their earnings forecast downward. Investors may want to wait till better visibility before investing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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