Vanguard offers more than 85 exchange-traded funds (ETFs). But in 2024, only five of them have outperformed the Nasdaq Composite‘s scorching hot 22.6% year-to-date return.
The top performer among them is the Vanguard S&P 500 Growth ETF (NYSEMKT: VOOG), which is up 27.4%. And while there are some risks to consider, it could continue beating the major indexes.
A top-heavy ETF
A brief look at the composition of the Vanguard S&P 500 Growth ETF reveals why it is outperforming both the Nasdaq Composite and S&P 500 in 2024. As its name would imply, it aims to hold the top growth stocks from the S&P 500. So naturally, it is more heavily weighted than the major indexes toward the world’s largest growth companies — Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta Platforms, and Tesla (collectively known as the “Magnificent Seven”).
In general, growth stocks have done incredibly well this year. And recently, even Apple and Tesla, which had been major underperformers, have gotten hot. Over 60% of the ETF’s value is concentrated in its top 10 holdings — the Magnificent Seven plus Eli Lilly, Broadcom, and Visa.
Over half of those top 10 holdings have well-outpaced the major indexes so far this year, particularly Nvidia, which is up 161%.
Any focused ETF that has a top holding put up that kind of performance is probably going to beat the benchmark. But what makes the Vanguard S&P 500 Growth ETF the single best-performing Vanguard ETF this year is its singular focus on large-cap growth stocks.
The fund’s strategy of not holding value stocks doesn’t always pay off (it severely underperformed in 2022, for example), but it has worked well this year. Better still for investors, there is reason to believe that the ETF is not overvalued — even after running up so much in a short period of time.
Premium prices for top stocks
The price-to-earnings ratio is one of the most popular valuation metrics for gauging whether a stock is a good value. Its beauty lies in its simplicity. It answers the key question: How are investors valuing a company relative to how much it earns in a year?
However, P/E ratios can be altered by one-off impairment charges or windfalls. A company could also drastically cut expenses one year, only to book a loss the following one. That’s why it helps to look not just at the P/E ratio based on the trailing 12 months of earnings, but also the forward ratio based on analysts’ consensus expectations for the next 12 months of earnings. In combination, these can offer a more accurate depiction of what a company is worth.
Here are the trailing and forward P/E ratios of the five largest holdings in the Vanguard S&P 500 Growth ETF
The forward P/E ratios of most of these stocks (except Apple) are considerably lower — implying that analysts foresee sizable earnings growth. Even Nvidia, which has a sky-high trailing P/E of more than 75, has a ratio below 50 based on its forward earnings estimates.
The Vanguard S&P 500 Growth ETF has a P/E ratio of 32.4– which is higher than the 29.4 multiple of the S&P 500. To justify that premium, the fund’s holdings will have to grow at a faster pace than the S&P 500.
Reasonable valuations (if growth delivers)
The key takeaway is that the top megacap growth stocks are arguably overvalued based on their trailing earnings, but not based on where their earnings could be a year or two from now.
Valuations — especially for growth stocks — depend more on perceived future growth than achieved growth. In other words, expectations matter more than what those companies have already accomplished.
For example, if Nvidia triples its earnings over the next five years but the stock price holds steady, then its P/E would be just 25. If the perception is that Nvidia’s best days are behind it, the stock price could quickly shift from carrying a growth-dependent premium to a discounted valuation and underperform the market. But if Nvidia can sustain an impressive growth rate, then investors may remain willing to pay a premium price for the stock — which could lead to a multi-year (or even a multi-decade) period of outperformance.
Microsoft offers a more moderate case. Assuming its P/E drops to 30 and it achieves a compound annual growth rate of 15% over the next 11 years, Microsoft would have a market cap of well over $10 trillion — well over triple where it is today. Most investors would jump at the opportunity to more than triple their money between now and 2035.
Yet a lot can go wrong over periods of several years. Factors outside of a company’s control can slow down growth. Unexpected competition can throw a wrench in expectations. Google is the dominant search engine, but Alphabet’s earnings would collapse if Google lost significant market share to a new rival. The same goes for Apple in smartphones or Tesla in electric vehicles.
No matter how wide a company’s moat is, there is always a risk that it will erode over time. Valuations are based on anticipated growth and market sentiment. And right now, growth expectations are high, and sentiment is positive. Even if growth stays strong, if sentiment shifts, there could be a sell-off in megacap tech names that would lead to a sizable slide in the Vanguard S&P 500 Growth ETF.
Check the growth box with the Vanguard S&P 500 Growth ETF
The Vanguard S&P 500 Growth ETF will likely be more volatile than the broader indexes. But with an expense ratio of just 0.1% — $1 a year in fees for every $1,000 invested — it remains a low-cost way to gain exposure to the top growth stocks in the S&P 500.
The ETF could be especially useful for investors who want more exposure to megacap growth stocks but don’t have strong investment theses for particular companies. Even at a premium price, investing in a basket of growth stocks still achieves diversification. The ETF could still fall considerably in a widespread growth stock sell-off, but at least those who put money into it are cushioned from the risks of any single company losing its edge over the competition or entering a downward spiral.
With any investment, it’s vital to understand what you’re getting into before you lay out your money. But the earnings growth history of the megacap tech companies is undeniable, their outlooks are generally strong, and this fund could easily continue outperforming the major indexes over the long term despite how expensive its largest holdings look right now.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, Tesla, and Visa. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
Vanguard’s Hottest ETF Is Now Up 27.5% in 2024. Here’s Why It Has More Room to Run in the Second Half of 2024 and Beyond. was originally published by The Motley Fool
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