How To Value Thematic Strategies

During the pandemic, we’ve seen an evolution of behavioral changes fuel transcendent trends across our economy that may create new future growth opportunities.

This has spurred investor interest in thematic ETFs that seek to provide exposure to firms at the forefront of innovation. In 2020, more than $40 billion flowed into ETFs focused on Future Communication, Clean Energy, Smart Transportation, and Cloud Computing.1

To formulate a fundamental view on these areas of innovation, it is important to consider which valuation metric may be the most appropriate.

Fundamentally thematic

Selecting the most appropriate metric requires understanding the type of firms typically found in the 145 funds we identify as thematic strategies. Our security look-through analysis finds many of these funds are concentrated in the Consumer Discretionary, Health Care, and Information Technology sectors. Importantly, the firms in those sectors typically have significant intangible assets2 on their balance sheets. Price-to-book may not be the best metric here because high intangible assets usually understate a firm’s book value—potentially inflating the firm’s price-to-book measure.

Earnings-related issues for thematics

There is an issue, however, if we use earnings-related metrics (e.g. price-to-earnings (P/E), price-to-next-12-month-earnings, and enterprise value-to-EBITDA). First, negative earnings firms must be removed, resulting in an incomplete exposure being analyzed. And those firms must be removed so as not skew the result (i.e., negative P/E values would tamp down the high P/E values when performing an average calculation for a portfolio).

The presence of negative earnings firms in some thematic exposures means any multiple that has earnings-related information in the denominator should not be utilized. This also holds true for the price-to-earnings-growth ratio (PEG), since it still relies on earnings in the denominator, while normalizing the ratio by expected growth.

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The views expressed in this material are the views of Matthew Barotlini through the period ended February 12, 2021 and are subject to change based on market and other conditions. ...

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