Are You Afraid of Overpriced Tech Stocks in Your ETFs?

by Andrew Hallam, Personal finance best-selling author

I’ll call the guy, Bob.

He recently posted a question on a Facebook investment forum.

“I want to invest in a globally diversified ETF, like Vanguard’s All-World ETF [VWRA]. But it has such a high emphasis on US technology stocks. I think they’re overvalued. What should I do?”

Bob isn’t wrong. Vanguard’s All-World ETF (VWRA) includes about 3,700 stocks. But almost 20 percent of its weighting is in just eight tech companies.

He’s also right when he says those stocks are expensive. When such pricey stocks plunge, they drag the entire index down.?

But what does “overvalued” mean? That’s always subjective. However, as Kenneth Fisher points out in The Only 3 Questions That Count, stock prices don’t rise much higher than corporate earnings growth, plus dividends over, say, a 20-year period.

Greed and fear move stocks over shorter periods. For example, according to The Value Line Investment Survey, Nvidia’s net business profits increased by about 450 percent over the past 5 years. That’s a lot. But over that same period, Nvidia’s stock price increased about 1,007 percent.

Benjamin Graham would have smiled. As Warren Buffett’s former mentor, and the author of The Intelligent Investor, Graham said the stock market is a short-term popularity contest, but a long-term weighing machine. Buffett says the same.

A stock’s business growth represents the number on the bathroom scale. Long-term, a stock’s price appreciation mirrors its business growth. That’s as close as investing gets to a law of physics.

Most of Nvidia’s investors don’t know how much the company made last year in business profits (it was about $32 billion). They don’t know how much corporate earnings have increased. Most of Nvidia’s investors bought it simply because, “The price went up.”? That facilitates more buying. And when there are more buyers than sellers, the price rises even more.

This doesn’t just happen with individual stocks. It can happen to entire sectors. That’s what concerns Bob. He fears buying Vanguard’s global ETF (VWRA) because most of America’s tech stocks have risen far faster than their corporate earnings over the past 10 years.

When that happens, there’s eventually a reckoning. Nobody knows, however, when that day will be. American tech stocks (which now represent a huge component of the US market) could crash this year or keep rising for another five.

Smart investors know they can’t time the market, so they have one of two choices. They could continue adding money to a globally diversified portfolio of ETFs. They might choose Vanguard’s FTSE All-World UCITS ETF (VWRA) and a global bond ETF, such as the iShares Core Aggregate Bond ETF (AGGG).

If you close your eyes, keep adding money, and never speculate, you will do well. Yes, your portfolio will plunge when tech stocks fall. But if you keep adding money, that should be a gift. After all, like stock market optimism, stock market pessimism always swings too far along the pendulum. At times, stocks will rise further than they should, based on giddy behaviours. But in the same vein, when investors are scared (during a crash) stocks also fall far further than they should.

By consistently buying every month or every quarter, Zen-like investors pay a lower-than- average price. If they add the same amount of money, that buys fewer stock market units when prices rise, and a greater number of units when stocks fall.?

But there is a second option.

If Ben thinks he’ll wet the bed when stocks fall, he could avoid high-priced tech. To do that, his entire portfolio could comprise the iShares Edge MSCI World Value Factor ETF (IWVL) and the iShares Core Aggregate Bond ETF (AGGG).

The iShares World Value ETF represents 398 low-priced global stocks. Those stocks have an average PE ratio of just 11.29X earnings. That means, if we took the combined business earnings of those corporations last year, it would take 11.29 years to buy 100 percent of every one of those companies, at current prices.

In contrast, the 7 largest companies of Vanguard’s All-World ETF (VWRA) have an average PE ratio of 45X earnings. That’s unusually expensive.

In fact, according to more than 100 years of market research, we have never seen such a huge price discrepancy between value stocks and growth stocks.

But are value stocks duds?

Not exactly. During the past, rolling 83-year periods, value stocks beat growth stocks 85 percent of the time.

In most cases, the stocks of companies with solid earnings and low prices eventually draw investors’ attention. They say, “Wow, look at these bargains and high dividend yields!”

For example, the top ten holdings in the global value ETF pay solid dividends. AT&T, Pfizer, Verizon and HSBC have dividend yields of 4.91%, 6.4%, 6.84% and 6.13% respectively.

A global value index with just 398 stocks isn’t as diversified as Vanguard’s FTSE All-World ETF.

But long-term, that might not matter with large-cap stocks. For example, the Dow Jones Industrials includes just 30 blue chip companies. The S&P 500 includes 500 stocks. Short-term, their performances differ. But long term, they don’t. Including reinvested dividends, the DOW averaged 8.90 percent from 1980-2024. Over the same period, the S&P 500 averaged 8.91 percent.

If you want a global value index, you could diversify further by adding small global stocks. Like value stocks, small stocks typically beat traditional indexes (like Vanguard’s FTSE All-World ETF) over long periods.

Based on historical, probabilities, the future long-term returns of a global value ETF and a global small-cap ETF should beat Vanguard’s All-World ETF.

But if popular tech stocks keep soaring over the next few years, would you have the strength not to own those shares? ?

Andrew Hallam is a Digital Nomad. He’s the bestselling author Balance: How to Invest and Spend for Happiness, Health and Wealth. He also wrote Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.