VAW: Materials Dashboard For December (NYSEARCA:VAW)

This monthly article series shows a dashboard with aggregate industry metrics in materials. It is also a review of sector exchange-traded funds (“ETFs”) like the Materials Select Sector SPDR ETF (XLB) and the Vanguard Materials ETF (NYSEARCA:VAW), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield (“EY”), Sales Yield (“SY”), Free Cash Flow Yield (“FY”), Return on Equity (“ROE”), Gross Margin (“GM”). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non available when the “something” is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for packaging in the table below is the 11-year average of the median Earnings Yield in packaging companies.

The Value Score (“VS”) is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score (“QS”) is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance.

Current data

The next table shows the metrics and scores as of last week’s closing. Columns stand for all the data named and defined above.

	VS	QS	EY	SY	FY	ROE	GM	EYh	SYh	FYh	ROEh	GMh	RetM	RetY
Chemicals	-12.27	8.09	0.0524	0.4733	0.0086	21.94	40.11	0.0437	0.4566	0.0217	17.97	42.63	-5.88%	-13.36%
Constr. Materials	44.76	61.92	0.0616	0.9993	0.0431	23.95	30.09	0.0318	0.8900	0.0336	10.91	28.85	-1.81%	-29.00%
Packaging	-4.98	14.56	0.0709	1.1388	0.0112	23.51	24.08	0.0482	1.0591	0.0368	17.66	25.07	1.29%	-7.77%
Mining/Metals	72.67	89.67	0.0968	1.4740	0.0374	23.73	24.52	0.0426	1.1834	0.0225	9.09	20.76	-2.87%	-0.24%

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Value and Quality chart

The next chart plots the Value and Quality Scores by industry (higher is better).

Evolution since last month

The value score has improved in chemicals, construction materials, and deteriorated in packaging.

Momentum

The next chart plots momentum data.

Interpretation

The highest-ranked subsector in value and quality scores is mining/metals. It is followed by construction materials. Both are undervalued relative to 11-year averages and their quality scores are far above the historical baseline. Packaging is close to the historical baseline in valuation, and above it in quality. The chemical industry is moderately overvalued, and quality looks good.

Fast facts on VAW

The Vanguard Materials ETF has been tracking the MSCI US IMI Materials 25/50 Index since 01/26/2004. It has a total expense ratio of 0.10%, the same as XLB. It is also available as a mutual fund (VMIAX).

The fund has 115 holdings, but it is quite concentrated in the top 10 companies, listed in the next table. They represent 49.1% of asset value. The top name, Linde Plc, weighs almost 14%. Risks related to other companies are moderate.

Ticker	Name	Weight	EPS growth %TTM	P/E TTM	P/E fwd	Yield%
LIN	Linde Plc	13.95%	11.11	43.76	27.43	1.41
APD	Air Products & Chemicals, Inc.	5.72%	10.58	31.37	27.75	2.05
SHW	The Sherwin-Williams Co.	5.10%	1.36	32.98	27.99	0.98
FCX	Freeport-McMoRan, Inc.	4.73%	0.02	14.49	16.51	0.79
CTVA	Corteva, Inc.	4.01%	-15.45	32.37	23.59	1.00
NUE	Nucor Corp.	3.27%	90.28	4.21	4.69	1.52
ECL	Ecolab, Inc.	3.20%	0.40	37.03	32.47	1.46
NEM	Newmont Corp.	3.13%	-50.26	36.14	24.74	4.83
DOW	Dow, Inc.	3.05%	-0.01	6.42	7.64	5.65
DD	DuPont de Nemours, Inc.	2.94%	-66.52	18.67	20.52	1.95

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Ratios from Portfolio123.

VAW has outperformed XLB in total return since inception (see next table). However, the difference in annualized return is only 40 bps. It also shows a slightly higher risk measured in drawdown and standard deviation of monthly returns (volatility). The difference in risk-adjusted performance (Sharpe ratio) is insignificant.

	Total return	Annualized return	Max Drawdown	Sharpe ratio	Volatility
VAW	403.91%	8.95%	-62.44%	0.45	21.55%
XLB	370.54%	8.55%	-59.66%	0.44	20.49%

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Data calculated with Portfolio123

In summary, VAW is a good product for investors seeking capital-weighted exposure in basic materials. It currently holds 115 stocks including large, mid- and small caps, whereas XLB invests in only 28 large companies. VAW is less concentrated in the top holdings: for example, LIN weighs 13.95% vs. 18.65% in XLB. XLB has much higher trading volumes, which makes it a better instrument for trading and tactical allocation strategies. Investors who are concerned by risks related to the top holding weight may prefer the Invesco S&P 500® Equal Weight Materials ETF (RTM).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a chemical company with an Earnings Yield above 0.0524 (or price/earnings below 19.08) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

X	United States Steel Corp.
OLN	Olin Corp.
CLF	Cleveland-Cliffs, Inc.
VRTV	Veritiv Corp.
CC	The Chemours Co.

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It is a dynamic, monthly list with a statistical bias toward excess returns on the long-term, not the result of an analysis of each stock.