ETF Fundamental Valuations for 2009

Which Exchange-Traded Funds are Opportunities this Year?

Feb 5, 2009

Though fundamental analysis is typically reserved for individual stocks, the strategy is still helpful when evaluating exchange-traded funds.

The economic debacle of 2009 took a toll on the stock market, including ETF investors who assumed their inherent diversity meant they would be shielded from excessive volatility. Now that the chips have fallen and the reality of risk has set in, investors are forced to rethink how they select any investment.

One area frequently overlooked by exchange-traded fund owners is fundamental analysis of their current or potential positions. The primary reason these individual may not look at the underlying fundamentals for a particular ETF is simply that the information isn't readily accessible. However, the information does exist.

The Select Sector SPDRs website assembles and publishes the average fundamental data for the underlying stocks in a their major sector ETFs. Depending on the fund, the information is posted in PDF format either weekly or monthly.

This information can be coupled with Standard & Poor's ongoing updates of past and projected sector valuations (Microsoft Excel required), also available at no cost. Though the S&P sector information isn't specific to any particular exchange-traded funds, the same basic information used to generate that data also makes up the ETF-specific data. So, it is possible to meaningfully compare current sector ETF valuations with the S&P's historical sector valuations.

Example

Certainly 2008's bear market deeply devalued many stocks and ETFs. However, which ones are the biggest bargains? Likewise, are any of them still on the expensive side?

To answer those questions, consider the average profitability measures for the stocks in each of the ten major sector SPDR exchange-traded funds as of the beginning of 2009. Then, compare those valuations to long-term norms.

Energy ETF (XLE)

Basic Materials ETF (XLB)

Consumer Discretionary ETF (XLY)

Healthcare ETF (XLV)

Based on this information, though the current P/E ratio is 6.6 may make the energy sector ETF look attractive, earnings are expected to weaken in 2009 (which would make the current price expensive by future standards). Conversely, healthcare stocks are not only priced attractively right now, but are expected to remain attractive even throughout 2009.

This isn't to say stocks and ETFs always trade at appropriate valuations, because they don't. It's also important to understand stocks and ETFs can become expensive if their prices rise while earnings stay flat, yet that still generates a gain for an investor. Healthcare could result in the opposite scenario -- the ETF could become cheaper by virtue of a falling price. So, this isn't a flawless strategy.

Nevertheless, this technique can help an investor make sound decisions when it concerns finding undervalued exchange-traded funds.

The copyright of the article ETF Fundamental Valuations for 2009 in Funds Investing is owned by James Brumley. Permission to republish ETF Fundamental Valuations for 2009 in print or online must be granted by the author in writing.