ETF Value Is in the Eye of the Beholder

by: Gary Gordon

If you look in one direction (e.g., Grantham, El-Arian, etc.), stocks are overvalued. If you look in another direction, (e.g., Doll, Fischer, etc.), stocks are seriously undervalued. Mercy… who should you listen to for investment guidance?

I won’t answer that directly. My feeling is (and has always been), manage the things that are in your control. You can control investment costs. You can also control the total portfolio’s dividend yield. And, believe it or not, you can secure the outcome of any single investment decision that you make.

It doesn’t matter whether you arrive at your investment selection through fundamental valuation, technical analysis or a dartboard. However, you can ensure that the outcome of your choice is a big gain, small gain or small loss… never a big loss. As long as you “cut your losses” through put option insurance or stop-loss protection or 200-Day MAs, you’ll succeed as an investor.

Obviously, having an investment discipline doesn’t change the undervalued-overvalued debate. It follows that viewing other people’s analyses may still help one make (or not make) an initial purchase.

Out at the popular web portal, Morningstar, its team of CFAs and CFPs collectively come down on the “undervalued” side of the coin. In the site’s 3/2/2010 “ETF Valuation Quickrank,” less than a handful of ETFs received “overvalued” labels. In contrast, there may be 50 or more “undervalued” ETF investments on the board.

According to the investment site, they reserve an ”undervalued” rating for ETFs that trade at significant discounts to their proprietary estimates of intrinsic worth. More specifically, Morningstar uses the undervalued tag for price-to-fair-value discounts of 8% on “lower-risk ETFs,” 15% price-to-fair value discounts on ”moderate-risk ETFs” and 20%-plus for ”above-average risk ETFs.”

Popular ETFs With Morningstar “Undervalued” Rating on 3/2/2010
Price/Fair Value Estimate
Regional Bank HOLDRS (NYSEARCA:RKH) 0.79
iShares Telecom (NYSEARCA:IYZ) 0.83
SPDR Select Healthcare (NYSEARCA:XLV) 0.83
Pharmaceutical HOLDRs (NYSEARCA:PPH) 0.84
Vanguard Value (NYSEARCA:VTV) 0.85
SPDR DJ Global Titans (NYSEARCA:DGT) 0.85
Dow Diamonds Trust (NYSEARCA:DIA) 0.89
S&P 500 SPDR Trust (NYSEARCA:SPY) 0.89

Nothing is particularly remarkable in the findings here. Healthcare ETFs and Telecom ETFs always seem to be rated as undervalued at Morningstar. That said, it doesn’t mean they aren’t a bargain either!

Perhaps the most intriguing Morningstar “bargain” is in the regional banking arena. Whether you opt for Regional Banking HOLDR (RKH) or KBW Regional Banks (NYSEARCA:KRE), a case can certainly be made for one of the most battered segments in 2009. Will regional banking be a big time winner in 2010?

In all, though, rating the Dow and the S&P 500 as undervalued by 10% is consistent with many projections at the start of the year. After all, what’s really changed since 1/1/2010? Not the market’s price.

It follows that if the market’s price is in the same spot, and companies earnings are actually increasing, then price-to-fair-value data would reflect a market that trades at a discount. Undervalued, then? Yeah… maybe. (Whether the market goes higher or not is a completely different story!)

Disclosure Statement: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The company does not receive compensation from any of the fund providers covered in this feature. Moreover, the commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.

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