Image Source: Pixabay
 

Although the rise of the largest technology stocks known as “The Magnificent Seven” has not yet reached return levels experienced midway through 2024, they are off to another relatively strong start as a group. One stock that has stood out in particular is Nvidia (Ticker: NVDA) which has risen so high, more than 82%, that it now has the highest market capitalization in the US. Many strategists have been in the media this week suggesting that the market is too dependent on NVDA, expressing fears that the perceived tech bubble could soon burst if tech leadership did not broaden. NVDA has gone through the roof because its hardware is essential for further development to most of the established leaders in the Artificial Intelligence race. Its recent 10-for-1 split underscores the company’s meteoric rise. However, as impressive as the rise of NVDA has been, opportunities in the tech sector clearly stretch below this one stock and its peers in the “Magnificent Seven.”

With an eye towards potential broadening of the tech sector opportunity set, this blog focuses on a few selected Technology ETFs, three of which target a broad segment of ETFs, most of which are not in QQQ, followed by a quick look at a few technology stocks most highly rated by ValuEngine. 

FXL - This ETF, sponsored by First Trust, offers exposure to the U.S. tech sector, making it one of many options available to investors seeking to access an industry that is capable of remarkable rallies and steep declines over short periods of time. Given the sector-specific focus, FXL may be too granular for those building a long-term, buy-and-hold portfolio, but can be useful for investors putting on a tactical tilt or looking to beef up tech sector exposure. FXL’s primary appeal is the use of the ‘AlphaDex’ methodology which seeks to select the best tech companies from the Russell 1000 Index universe. This is done by ranking the firms on a variety of growth and value factors including momentum, ROE, and CF/P just to name a few. Thanks to this method, the fund casts a much smaller net than others in the sector, holdings just 85 securities.

PSCT – This ETF, sponsored by Invesco, tracks a broad index of small companies in the information technology sector which the issuer considers to be the following areas; software, internet, electronics, semiconductors, communication and hardware. As a result, this fund tracks some of the quickest growing and most volatile companies in the technology sector. The fund focuses entirely on U.S. stocks and is relatively well spread out; it holds 130 securities in total and puts just 19.5% in its top ten holdings. Investors should also note that while this is a small cap fund it also offers exposure to other asset class sizes as well; mid-caps make up almost 2.1% while micro caps make up nearly 30% as well. As a result, this fund will be more of a growth play than one that presents strong value opportunities for investors. Therefore, this fund could make an interesting potential complement for investors who are bullish on tech but already have significant exposure to large caps; this fund could provide a different mix of companies and add to overall diversification within the sector.

QQQJ - The Invesco Nasdaq Next Gen 100 ETF (QQQJ) tracks an index of the largest non-financial stocks listed on Nasdaq that aren’t included in the Nasdaq-100 index.  Many Nasdaq specialists refer to this ETF as Q Junior. QQQJ gives investors easy exposure to Nasdaq stocks positioned for potential growth. For investors concerned about a size bias in their tech holdings, Q Junior can also help offset the large-cap tilt of QQQ and QQQM.

These three ETFs are compared to two much larger ETFs dominated by stocks included in “The Magnificent Seven.” 

XLK - State Street’s XLK is known as the Technology Select Sector SPDR Fund. To be included in this ETF, an S&P 500 Constituent must be one of numerous sectors under the technology umbrella. This includes market segments like IT services, wireless telecommunication services, and semiconductors to name just a few. The fund invests in the who’s-who of the U.S. tech sector, with major holdings in companies like Apple and IBM. With just 66 stocks, it is the narrowest of the ETFs featured in this analysis.

QQQ – The Invesco QQQ Trust Series I offers exposure to what has become one of the world’s most widely-followed equity benchmarks, the Nasdaq-100.  It is popularly considered the standard-bearer for the US tech sector. This is true even though it includes stocks that aren’t in the tech industry and omits tech stocks not listed on the Nasdaq.  The liquidity of this ETF as a trading vehicle is nonpareil. That said, investors buying new shares for a long-term investment in US technology stocks may wish to use QQQM instead of QQQ. The Invesco Nasdaq 100 ETF (note the original was designed as a Unit Investment Trust), QQQM is often referred to as the Q Mini. This sounds a lot like the Q Junior but do not be confused. QQQM holds precisely the same portfolio as QQQ. The “mini” aspect is that it has a lower expense ratio, 0.15% as compared with 0.20% for QQQ. Of course, XLK, discussed in the above paragraph gives investors pure tech exposure, including companies listed on the NYSE and the Cboe, and does so for an even lower expense ratio, 0.09%.   

Here is the table comparing the 5 ETFs.

The first thing that stands out in this table is that ValuEngine’s model rates all 5 ETFs as below the “Hold” threshold.  FXL, QQQJ and QQQ are rated 2 for Sell while PSCT and XLK are rated 1 for Strong Sell. Note that these ratings relate to the dismal, below-zero-return, one-year price-return forecasts for all 5 ETFs. The 3-month and 6-month outlooks are a bit more positive across the board. XLK has the best performance track record throughout the past 5 years and ties for the highest dividend yield although all of them are paltry. Tech is not the sector to invest in for current income or low valuations. That said, FXL has a P/E ratio of just 16.4 which is below market average. Taken altogether, though, ValuEngine’s forecasting model indicates that short-term-to-one-year investors may want to consider using these ETFs as sources of funds for other investments.

However, there are several individual stocks in the sector that our predictive model likes. The following stocks are all rated 4 (Buy) or 5 (Strong Buy) and have market capitalizations of $20 Billion or greater.

NOW - ServiceNow, Inc. provides end to-end intelligent workflow automation platform solutions for digital businesses in North America, Europe, the Middle East and Africa, Asia Pacific, and internationally. The company operates the Now platform for end-to-end digital transformation, artificial intelligence, machine learning, robotic process automation, process mining, performance analytics, and collaboration and development tools. ServiceNow, Inc. was founded in 2004 and is headquartered in Santa Clara, California.

PINS - Pinterest, Inc. operates as a visual search and discovery platform in the United States and internationally. Its platform allows people to find ideas, such as recipes, home and style inspiration, and others; and to search, save, and shop the ideas. The company was formerly known as Cold Brew Labs Inc. and changed its name to Pinterest, Inc. in April 2012. Pinterest, Inc. was incorporated in 2008 and is headquartered in San Francisco, California.

SNAP - Snap Inc. operates as a technology company in North America, Europe, and internationally. The company offers Snapchat, a visual messaging application with various tabs, such as camera, visual messaging, snap map, stories, and spotlight that enable people to communicate visually through short videos and images. It also provides Spectacles, an eyewear product that connects with Snapchat and captures photos and video from a human perspective; and advertising products, including AR ads and Snap ads comprises a single image or video ads, collection ads, dynamic ads, story ads, and commercials. Snap Inc. was founded in 2010 and is headquartered in Santa Monica, California.

DOOR - DoorDash, Inc., together with its subsidiaries, operates a commerce platform that connects merchants, consumers, and independent contractors in the United States and internationally. The company operates DoorDash Marketplace and Wolt Marketplace, which provide various services, such as customer acquisition, demand generation, order fulfillment, merchandising, payment processing, and customer support. It also offers membership products, including DashPass and Wolt+; DoorDash Drive and Wolt Drive, which are white-label delivery fulfillment services that enable merchants that have generated consumer demand through their channels to fulfill demand using its platform; DoorDash Storefront that enables merchants to offer consumers on-demand access to e-commerce; and Bbot, which offers merchants digital ordering and payment solutions for in-store and online channels. DoorDash, Inc. was founded in 2013 and is headquartered in San Francisco, California.

WDC - Western Digital Corporation develops, manufactures, and sells data storage devices and solutions internationally. It offers client devices, including hard disk drives (HDDs) and solid state drives (SSDs) for desktop and notebook personal computers (PCs), gaming consoles, and set top boxes; and flash-based embedded storage products for mobile phones, tablets, notebook PCs, and other portable and wearable devices, as well as automotive, Internet of Things, industrial, and connected home applications. Western Digital Corporation was founded in 1970 and is headquartered in San Jose, California.

The following table compares the companies on their vital statistics. They are clearly all positioned as growth companies. None of the four pay dividends and all sell at extraordinarily high traditional price-to-earnings multiples.

Observations

1. These technology stocks are all highly volatile and do not pay dividends.  The valuations from a P/E perspective are quite extraordinarily high, even when compared with QQQ.
2. One of two exceptions to overvaluation, SNAP is considered the most undervalued stock relative to our universe according to our valuation model which factors in growth expectations for the stock. The other exception is Western Digital.  WDC has a modest 2.1 price-to-sales ratio and a very low PEG (price-to-earnings-growth) ratio of 0.1,
3. Western Digital (WDC) also stands apart from the others as being more tangible.  It’s the only firm of the five that’s been in business more than 50 years, and it makes hardware and other physically tangible products.  The other four are all successful service, software and social media providers.
4. Even alongside the other 5-rated stocks, DoorDash stands out to our model as having the highest projection for price gains in the next three to 12 months.  On the other hand, it is by far and away the most volatile of the five stocks both by Standard Deviation and Beta.  

In conclusion, our predictive model and valuation model both are bearish on technology in general but they’ve mentioned a few hidden gems.  Investors interested in staying in the sector but paring positions in Apple, Nvidia and Tesla may find some of these stocks worth investigating.  However, such investors should fasten their seatbelts as all of these stocks are very volatile and many experts predict increased market volatility for the next 6 months.

More By This Author:

T + 1 Now A Reality But Why Should I Care?
A Not-So-Brief History Of Quantitative Investing Since 1900
The Terrible Ten