Investment Thesis
The Vanguard Information Technology ETF (NYSEARCA:VGT) is one of the best and most consistent choices available to long-term tech- and growth-focused investors. My annual returns analysis from 2008-2022 found that VGT ranked #4/23, #2/21, and #3/16 on a 5Y, 10Y, and 15Y basis, performing favorably compared to popular alternatives like XLK, SCHG, and QQQ. In addition, VGT's fundamentals are competitive with its peers and features an 11.05% estimated earnings growth rate and a 31.6x forward earnings valuation. While I am concerned with this valuation and am slightly discouraged by VGT's relatively low profitability score, there's no denying its excellent long-term track record. For readers wanting increased tech exposure, VGT is a great option, and I look forward to taking you through the reasons why in more detail below.
VGT Overview
Strategy Discussion
VGT tracks the MSCI US Investable Market Information Technology 25/50 Index, selecting U.S. Technology securities of all sizes according to Global Investment Classification Standards. Previously, MSCI's market-cap-weighted Indexes rebalanced at the end of May and November. However, future rebalancings will be quarterly, as described here. This rebalancing schedule impacted VGT's holdings until June 1, 2023, because they did not reflect the March GICS changes.
VGT is competitively priced with a 0.10% expense ratio. It's also well-established with a 22+ year track record and over $57 billion in total assets. Below is a fund profile comparison with the Technology Select Sector SPDR ETF (XLK), the Schwab U.S. Large-Cap Growth ETF (SCHG), and the Invesco QQQ ETF (QQQ).
Top Holdings
Vanguard's holdings section is only updated near the middle of the next month-end, meaning the data could be as much as 45 days old. However, investors can always view the latest Portfolio Composition File after agreeing to Vanguard's terms of use. Based on the number of shares listed, Apple (AAPL) and Microsoft (MSFT) comprise 21% of VGT each, followed by Nvidia (NVDA), Broadcom (AVGO), and Salesforce (CRM).
VGT's top ten holdings as of April 30, 2023, are listed below. Notice how Visa (V) and Mastercard (MA) were the fourth- and fifth-largest holdings at the time, but they now are #3 and #4 in the Vanguard Financials ETF (VFH).
Performance Analysis
VGT has been a reliable broad-based tech ETF since its launch in January 2004. To illustrate its long-term success, I've compiled annual returns from 2005 onwards for VGT and 24 technology-focused or broad-based growth ETFs. VGT's percentile rankings are in the bottom rows for its segment (i.e., technology) and the entire sample.
Evaluating performance this way is crucial because it diminishes the impact of market timing. For example, an ETF could have a terrific three- or five-year chart, but a single exceptional year unlikely to repeat skews the results. VGT is rarely a bottom-quartile performer, indicated by a percentile ranking above 75%. Only four times did this occur: 2009, 2010, 2013, and 2016, gaining 61.89%, 12.78%, 30.96%, and 13.77%. In other words, your assets still grow when VGT underperforms its peers. These are all solid annual gains, and while VGT is never a top performer, it likely won't steer you wrong for too long. Consider these additional statistics:
- Average 15Y Annual Gain (2008-2022): 16.60% (#3/16)
- Average 10Y Annual Gain (2013-2022): 30.96% (#2/21)
- Average 5Y Annual Gain (2018-2022): 19.57% (#4/23)
This consistency is what produced VGT's excellent long-term track record. The following table highlights its performance against the three ETFs I will compare it with today: XLK, SCHG, and QQQ.
XLK is a close tech-focused competitor to VGT, as it's also a plain-vanilla market-cap-weighted ETF but holds only S&P 500 constituents. Meanwhile, SCHG and QQQ are broad-based growth funds with significant exposures to the Technology sector. Increased diversification and exposure to other growth stocks like Alphabet (GOOGL) are reasons to own.
VGT's 17.52% annualized gain since January 2010, SCHG's first full month, matched XLK's 17.51%. QQQ was slightly behind, with a 17.41% per year gain, while SCHG was the outlier. Schwab's low-cost large-cap growth ETF gained 3% per year less, something I attribute to a consistently high P/E ratio. On average, SCHG placed in the third quartile (58% percentile) from 2010-2022, while VGT was slightly better at the 54th percentile. The difference may seem minor, but the reason for the poor compounded returns was a 9.03% and 12.59% underperformance in 2017 and 2019. Importantly, SCHG has not beaten VGT since 2013, so it's reasonable to believe VGT is superior.
The only negative performance statistic is VGT's higher volatility, measured by its 18.57% standard deviation and lower risk-adjusted returns (Sharpe and Sortino Ratios) vs. XLK and QQQ. That's typical for an ETF that includes some small- and mid-cap stocks, and what usually accompanies this is a loss of quality and more significant drawdowns. We see that in VGT's drawdown comparison with XLK below. In most cases, VGT's declines are 1-3% more, but the recoveries are usually quick. This may not concern a long-term investor.
Fundamental Analysis
Overlap With Peers
I want to highlight how many ETFs listed earlier overlap substantially. Using the Fund Overlap Tool at the ETF Research Center, I compiled the following overlap matrix for ten of the largest by AUM. It's only partially accurate since these third-party tools still use VGT's April 30 holdings. However, it will provide some perspective to those wanting to allocate their capital efficiently.
All ETFs had between 50-70% overlap on average as of April 30, 2023. VGT's was 79%, 50%, and 52% with XLK, SCHG, and QQQ, but that's changed since the latest reconstitution. Currently, it's 84%, 73%, and 72%. Therefore, these ETFs are similar, and your preference might depend on how diversified you want. Apple and Microsoft control 43% and 47% of VGT and XLK, compared to 27% and 26% for SCHG and QQQ.
Fundamental Analysis
The following table highlights selected fundamental metrics for VGT's top 25 holdings, covering 76% of the portfolio. As measured by the five-year beta figure, market volatility is similar for all four, but it trends lower based on how focused each ETF is on a single sector. VGT and XLK are at 1.21 and 1.20, while the more diversified SCHG and QQQ are at 1.16 and 1.17.
VGT's estimated sales, EBITDA, and EPS growth rates are between 10-11%, which is, on average, slightly better than XLK and QQQ but behind SCHG. I mentioned earlier how SCHG's high P/E is likely its source of poor historical returns, and that's on display here. SCHG trades at 33.21x forward earnings and lags the other three YTD through May.
A final consideration is quality, as measured by profitability. After weighing and normalizing Seeking Alpha's Profitability Grades on a ten-point scale, XLK and QQQ score the highest at 9.81/10 and 9.77/10, followed by SCHG at 9.59/10. VGT's 9.33/10 is the lowest, primarily because it takes a total-market approach and holds smaller, less profitable companies. Logically, investors should pay a premium for higher-quality stocks, but the question is if a 9.33/10 score is sufficient. For this, I turned to Ken French Data Library for answers. I calculated some statistics for high-, medium-, and low-operating profitability portfolios for the large-cap segment (value-weighted). You can download the source file here.
1. From 1964-2022, the large-cap high- and low-profitability portfolios gained 12.77% and 9.85% on average. For buy-and-hold investors, this is important news. Focus on high-quality businesses that make money, and you'll be rewarded in the long run.
2. From 1964-2022, the high- and low-profitability portfolios earned the same 43% "best return" in 1991 and 2013, respectively. Recall from the annual percentile rankings table how the Invesco S&P 500 Pure Growth ETF (RPG) delivered the best returns in 2013. RPG's profitability score is only 8.96/10, and you can see the lower profitability's impact on long-term returns in the table below. Against the more diversified SPDR S&P 500 Growth ETF (SPYG), RPG lagged by 1.30% per year (9.25% vs. 10.55%) and was more volatile between April 2006 and May 2023.
Therefore, profitability scores below 9/10 may be insufficient, which is different than what I previously thought. VGT's 9.33/10 score might be pushing it, as 16% of the portfolio scores below the 9/10 threshold, which is an "A-" or worse Seeking Alpha Profitability Grade. In contrast, just 3% of XLK's constituents fall below the threshold.
3. From 1964-2022, the high- and low-profitability portfolios had their worst years in 1974 and 2008, declining 31.38% and 47.82%, respectively. These results demonstrate how profitability can act as a shield in market downturns.
4. In the last 20 years, from 2003-2022, the high-profitability portfolios delivered a better average annual gain (12.74% vs. 9.55%) and a 19% outperformance in 2008. However, the low-profitability portfolio did have a 43% gain in 2013, outpacing the high-profitability portfolio by 12%. Very few thematic ETFs were operating at the time, and I doubt it's a coincidence that Cathie Wood's Innovation ETFs launched the following year (ARKK, ARKQ, ARKW, ARKG). Low-profitability portfolios can succeed, but once you understand the history behind how these portfolios perform in the long run, there is little basis for a long-term position.
Investment Recommendation
VGT is a low-cost, plain-vanilla market-cap-weighted tech ETF with an excellent long-term track record. Even more impressive is how VGT ranked near the top on average 5Y, 10Y, and 15Y returns against its peers, including XLK, SCHG, and QQQ. Investors should have confidence in its success, as VGT is priced similarly to its peers for the estimated growth and valuation featured. I already own SPY and have enough exposure to the sector, so I won't recommend it as a buy today. However, less conservative investors might want to overweight the sector, and VGT is one of the best ways to do so.
Still, I have two cautionary notes. The first is that we only have one above-average earnings season behind us, as detailed here. The large-cap Technology sector didn't deliver a substantially higher earnings surprise than the broader market (7.9% vs. 7.1%), so VGT's 31% gain this year might partially reverse. Second, VGT has 16% of its weight dedicated to stocks with "A-" or worse Profitability Grades. My analysis reveals a preference for higher-profitable portfolios over the long run, so XLK could be a better choice. You'll have to weigh that negative against VGT's track record. Regardless, I hope this analysis was informative, and I look forward to continuing the conversation in the comments section below. Thank you for reading.
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