Invest in an Equal-Weight ETF in these Turbulent Times.

The S&P 500 index is market-capitalization-weighted. The weighting by market cap means the companies with the largest market capitalization (Market capitalization = Number of shares outstanding x Share Price) get the highest weight. Last year, this method for calculating the index made the five largest companies by market cap account for 23% of the index. That is just 5 out of the 500 companies accounting for about a quarter of the market capitalization. These five companies were: Apple, Microsoft, Alphabet (Google), Amazon, and Facebook (Meta). When the share price of these companies starts underperforming, the market takes a huge tumble. We can see that happening now. The S&P 500 index (VOO) is down about 9.72% (pre-market on January 28), while the S&P 500 equal-weighted ETF (RSP) is down 7.48% (See Exhibit 1: Invesco Equal-Weight ETF Beats Vanguard S&P 500 Market-Cap Weighted ETF). That is a difference in the performance of 224 basis points. In essence, the equal-weight ETF outperformed the market-cap ETF. The dividend yield is about the same for both ETFs. The Invesco Equal-Weight ETF charges a higher expense ratio than the Vanguard S&P 500 ETF. Invesco charges 20 basis points (bps) or 0.2%, while the Vanguard S&P 500 ETF (VOO) charges three bps or 0.03%. Invesco charges 7x more than the Vanguard ETF. Even after deducting the extra expense of investing in the Invesco ETF, it comes ahead in performance by over 200 bps.  

The era of big-tech is coming to an end due to more regulation and their size inhibiting growth. At least for now, Apple seems to be bucking the trend after reporting blockbuster results yesterday. Interest rates are also rising, putting pressure on valuation because future earnings will be discounted at a higher interest rate. It may be good to have a position in the Invesco Equal-Weight ETF (RSP) during these times. 

     Exhibit 1: Invesco Equal-Weight ETF Beats Vanguard S&P 500 Market-Cap Weighted ETF

(Source: Seeking Alpha)

Also, there may be other equal-weight ETFs in the market. I am aware of Invesco's ETF, so I have invested in it. I am not endorsing the Invesco ETF. 

Can Salesforce (CRM) continue growing to justify its valuation?

Salesforce (CRM) grew at a breakneck speed over the past two decades. The is hoping that the growth will continue in this decade.

The company's free cash flow yield is very similar to that of Microsoft (MSFT) and Adobe (ADBE). Salesforce's free cash flow yield has been consistently around the 2% level over the past decade. Microsoft and Adobe have seen their market capitalization and earnings multiple expand over the years causing their free cash flow yield to drop. I might have to look into their number more closely. 

Exhibit: Free Cash Flow Yield

(Source: Seeking Alpha)

Salesforce is lagging behind Microsoft (MSFT) and Adobe (ADBE) on return on equity. Both those companies have more than 8x more return on equity than Salesforce.  

  Exhibit: Return on Equity

(Source: Seeking Alpha)

Microsoft and Adobe have 6x and 8x more return on invested capital (ROIC) compared to Salesforce. 

Exhibit: Return on Invested Capital 

(Source: Seeking Alpha)

Salesforce's EBITDA margin is much lower than that of Microsoft and Adobe.  

Exhibit: EBITDA Margin

(Source: Seeking Alpha)

Salesforce's EV to EBITDA multiple is higher than that of Microsoft and Adobe.  

                               Exhibit: EV to EBITDA Multiple for Salesforce, Microsoft, and Adobe.  

                                        

   (Source: Seeking Alpha)                                         

Salesforce's year-over-year quarterly revenue growth (See Exhibit: Year-over-Year Revenue Growth) has converged with Microsoft and Adobe.  

    Exhibit: Year-over-Year Revenue Growth

(Source: Seeking Alpha)

Salesforce's price to earnings growth ratio (See Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio) was attractive during the past decade compared to Microsoft and Adobe. If the company's growth can continue, that would justify its higher valuation multiple compared to Microsoft and Adobe. Salesforce's revenue is already in the high $20 billion, so for it to grow at a 20% rate would take some work.  

                                        Exhibit: Salesforce, Microsoft, and Adobe PEG Ratio

(Source: Seeking Alpha)

Western Digital Had Good Earnings. But Gross Margins Could Improve

Western Digital (WDC) Saw its revenue increase by 18% YoY. It had another record quarter for its flash storage business. Two out of its three business segments did very well. How many companies in today's economy can actually say that it's growing revenue at a double-digit pace?  If you look at the Dow Jones Industrial Average (DJIA) 20 out of 30 companies in that index saw YoY EPS decline. 

Exhibit: WDC showed good revenue growth in Q4 FY 2020

(Source: SeekingAlpha)

Its Data Center business continue growing and its revenue increased 32% YoY. Its Client Devices business grew revenue by 19% YoY. But due to the closure of retail stores because of the pandemic, its Client Solutions business suffered.

(Source: SeekingAlpha)

The company has made it a priority to pay down debt. Its gross margins have shown improvement but it could improve further. Gross margin percentage has gone from 24.2% in Q4 FY 2019 to 28.9% in Q4 FY 20.

(Source: SeekingAlpha)

(Source: SeekingAlpha)

For example, the company's non-gaap gross margins were at 43% in Q2 of FY 2018.  So, it's possible for Western Digital to improve its gross margins substantially. 

Exhibit: In Q2 FY 2018 WDC had Good Gross Margins. It's possible for WDC to get to this level again. 

(Source: SeekingAlpha)

I see there could be two drivers for gross margin improvement in the second-half of the year.

• The release of new video game consoles from Playstation and Xbox should drive demand for storage demand and lift the average selling price (ASP)
  
• The company's 16-TB and 18-TB hard drives based on HAMR technology should see good demand in the cloud space. 
  

I had recently done an article on SeekingAlpha and I had covered both Micron (MU) and Western Digital as part of that.      

(Disclosure: I own both MU and WDC)          

Big Tech is Taking a Break From the Rally

    Both Apple (AAPL) and Microsoft (MSFT) are trading below its 10-day moving average. Apple is down from its 52-week high of $399.82 and currently trades at $380.16. That's a drop from the 52-week high of - 4.97%. Apple's 10-day moving average is 382.436 (Tuesday, July 28, 2020). Microsoft is down from $216.38 to $204.06 that's a -5.6% change. Its 10-day moving average is $202.15. Amazon (AMZN), Facebook (FB), and Alphabet (GOOG) are all trading below their 10-day moving average. Out of this cohort only Facebook is trading below its 50-day moving average. 

Exhibit: Big Tech's Downturn has Started. When will it end? 

(Source: SECURFII)

    Microsoft has gained 53% from its lows in March 2020. Apple has gained 76% form its March 2020 lows.  The gains have been spectacular. Google has gained 50% from its March lows. Amazon has gained nearly 82% from its March 2020 lows.     

    It seems like all these stocks are starting a downward trend after the huge run-up they have had over the last few years and the rebound they have had since the pandemic induced crash of March 2020.