Discovering Value in Growth Stock Funds: Biotech ETFs

  • The Value ETF Investor need not fret if they don’t own any Growth Stock funds yet
  • Biotech Stocks are generally considered Growth Stocks
  • Will the Biotech Industry get much cheaper?
  • Why FBT is top dog in the Biotech ETF space
  • Charts updated 5-30-17

As a dad of seven kids and a grandfather to 11, I have often been accused of being cheap; but I prefer the term frugal. I guess you could say that 30 years of frugality has fed over into my investing style. I like growth stocks, but I just can’t get myself to pay up for them. So, I’ve put some Growth sector and style ETFs on the list of 30 ETF’s that I invest in. Sometimes, but not often, one of these Growth sectors or styles will rank very high on my list as a buying opportunity. That’s where the First Trust NYSE Arca Biotech ETF (FBT), comes into play. FBT is a shining star in the Health Care sector and Biotech industry. I have a personal preference for ETFs that have been around for at least 10 years or have an inception date before November 2007. That does limit me, possibly, from some better ETF’s, but with more than 1900 ETF’s to pick from, I must draw the line somewhere. I will explain later, why FBT is my favorite ETF in the Health Care sector.

Let’s start off with a chart comparing the returns of the oldest, and largest Health Care ETF, the Health Care Select Sect SPDR ETF, XLV with the Vanguard 500 Index Fund, VFINX.

 

As you can see, the XLV ETF clearly outperforms the VFINX index fund over the last 17 years. Also, the correlation to the S&P 500 is 0.77. That’s enough to get me interested in putting a portion of our nest egg in this sector.

Next, let’s look at some previous buying opportunities in the oldest and perhaps most popular Biotech ETF, the iShares Nasdaq Biotechnology ETF, IBB.

 

In the chart above, you can see that in the last 15 years, there’s only been about 6 significant downturns in the IBB ETF. These downturns usually prove to be good entry points. Biotech is currently experiencing an impressive bear market, (-28%). Will Biotech get any cheaper? Possibly. Can Biotech drop another 25% as it did back in the early 2000’s. Yes, yes it can. Does that scare me? Yes, I admit, it does a little, but not enough to keep me from adding some here and there to my portfolio.

Next, I’ll show you why I consider the First Trust NYSE Arca Biotech ETF, FBT, the best in class in the Health-Care sector. I back tested every non-leveraged Health Care ETF that had an inception date prior to November 2007 and FBT came out on top every time. I will not bore you with the details of that, but I did decide to show the back test of FBT against the 2 most popular Biotech ETF’s, iShares Nasdaq Biotechnology ETF, IBB and SPDR Biotech ETF, XBI.

 

I do like FBT‘s performance in this chart, but another reason I prefer FBT over the others is that it is equal-weighted. You can read here about equal weighted vs cap weighted indexes. Additionally, the average size of the companies in FBT is smaller than IBB and I believe there is still some risk premium to be discovered in smaller companies.

I don’t pay a lot of attention to valuations on the ETF’s that I purchase since I’m buying a fund and not a stock. But, if the chart below is correct, then maybe Biotech stocks aren’t actually growth stocks anymore. You can find this chart on page 8 of this document. Since I don’t consider valuations much, I’m not overly concerned when I see on First Trust’s own website that FBT’s P/E ratio is 20.75. If valuations are important to you, you may need to do further research.

Valuable value quotes:

  • “Value investing at its core is the marriage of a contrarian streak and a calculator.” – Seth Klarman
  • “When everybody is on one side of a listing boat, it’s time to walk to the other side.” Micah McDonald

I know that the future of FBT and the other health care ETF’s is currently bleak. And, I know that the future will not necessarily look like the past, but I am willing to take the risk that the future for biotech will at least rhyme.

Conclusion: I believe now is a good time for the contrarian investor to consider adding Biotech or Health Care ETFs to their portfolio. If you’re a long-term, value ETF investor, as I am, now is an excellent opportunity to add a “growth stock” Health Care ETF to your portfolio. It is my contention that FBT is the best-in-class in both the Health-Care sector and the Biotech industry.

Micah McDonald, aka The Deep Value ETF Accumulatordvetf.comhttps://deepvalueetfaccumulator.com/

Thank you to portfoliovisualizer.com  for the back-testing tools.

Thank you to etfdb.com for the ETF screening tools.

Thank you to yardeni.com for the PDF about S&P 500 Sectors & Industries Forward P/Es

 

 

 

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