How to Value Thematic Strategies

By:

Head of SPDR Americas Research

  • This year, more than $30 billion has flowed into thematic ETFs.1
  • With all this interest, due diligence on the underlying exposures is necessary.
  • Yet, which valuation metric is most appropriate to use when trying to formulate a fundamental view on areas of innovation?

Investor interest in thematic ETFs that seek to provide exposure to firms at the forefront of innovation in our new economy continues to surge. More than $30 billion has flowed into thematic ETFs— strategies focused on such areas of innovation as: Future Communication, Clean Energy, Smart Transportation, and Cloud Computing.

With all this interest, due diligence on the underlying exposures is necessary, as many of these strategies deviate from owning just large, mega-cap tech stocks and venture into smaller firms that are not as well known. One of the areas of analysis that has routinely come up is valuation, and in this blog, I will walk through which valuation metric is most appropriate to use when trying to formulate a fundamental view on areas of innovation.

Fundamentally Thematic

Before we delve into the intricacies of valuation multiples, there is one caveat to mention: many of these strategies are within the “growth” category. In fact, out of the 206 funds we have identified as thematic, 147 have more than 50% allocated to “growth” stocks.3 Given that traditional growth stocks are trading above the 90th percentile across price-to-book, price-to-earnings, price-to-next-12-months-earnings, price-to-sales, enterprise value-to-sales, and enterprise value-to-EBIDTA,4 it would follow that these nontraditional growth stocks are also likely to end up in a similar “high-valuation-multiple” place.

But what metric to use? To answer this, we need to understand the type of firms typically found within these strategies. When performing a security look-through analysis on the funds, we find that many are concentrated in Consumer Discretionary, Health Care, and Information Technology sectors, as shown below. This is important, as the firms within those three sectors typically have a large amount of intangible assets on their balance sheets. And price-to-book is not the best metric to use when a firm has a high amount of intangible assets,5 as those assets are usually understated in a firm’s book value, and, as a result, that could inflate a firm’s price-to-book measure. However, one advantage of price-to-book is that it can be used with firms that have negative earnings – a trait that may be valuable in this exercise. Despite the latter feature, the high presence of intangibles leads to price-to-book not being a suitable metric for thematic strategies.

Average Sector Weights of Thematic Exposures

Average Sector Weights of Thematic Exposures

Click here to read the full article

Footnotes

Bloomberg Finance L.P. as of December 17, 2021.
2 Bloomberg Finance L.P. as of December 17, 2021.
3 Bloomberg Finance L.P. as of December 3, 2021 based on SPDR Americas Research calculations.
4 Bloomberg Finance L.P. as of December 3, 2021 based on the S&P 500 Growth Index based on data from March 1994.
5 An intangible asset is an asset that is not physical in nature. Goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets. Intangible assets exist in opposition to tangible assets, which include land, vehicles, equipment, and inventory.

Glossary

Enterprise Value-to-EBITDA (EV/EBITDA)
The enterprise value (EV) to the earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio varies by industry. EBITDA measures a firm’s overall financial performance, while EV determines the firm’s total value.

Enterprise Value-to-Sales (EV/S)
A financial valuation measure that compares the enterprise value (EV) of a company to its annual sales. The EV/sales multiple gives investors a quantifiable metric of how to value a company based on its sales, while taking account of both the company’s equity and debt.

Price-to-Book Ratio (P/B)
Used to compare a firm’s market capitalization to its book value calculated by dividing the company’s stock price per share by its book value per share (BVPS). An asset’s book value is equal to its carrying value on the balance sheet, and companies calculate it netting the asset against its accumulated depreciation.

Price-to-Earnings Ratio (P/E)
The ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). The price-to-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

Price-to-Sales Ratio (P/S)
Calculated by taking a company’s market capitalization (the number of outstanding shares multiplied by the share price) and divide it by the company’s total sales or revenue over the past 12 months. The lower the P/S ratio, the more attractive the investment.

S&P 500 Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.

Originally Posted on December 21, 2021 – How to Value Thematic Strategies

Disclosures

The views expressed in this material are the views of Matthew Barotlini through the period ended December 3rd, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent.

The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.

Investing involves risk including the risk of loss of principal.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from State Street Global Advisors and is being posted with permission from State Street Global Advisors. The views expressed in this material are solely those of the author and/or State Street Global Advisors and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.