New Solid State Drive ETNs Are Good Buy

by: Diffusion

Best investments are often found with solid fundamentals and creditable growth prospects. The newly incepted Solid State Drive ETNs are promising candidates.

UBS introduced yet another two niche tech ETFs: the Solid State Drive ETN (NYSEARCA:SSDD) and its twice leveraged sister (NYSEARCA:SSDL). For background information please refer to Michael Johnston’s comprehensive piece.

Because a solid state drive (SSD) has no moving parts, it is less likely to be damaged when being moved around. This feature makes SSD a suitable component for portable devices such as iPads. Although PC demand was weak lately, analysts kept raising their estimations for iPads. Plus other device manufacturers are trying to duplicate Apple’s success, or at least take a share of Apple’s creamy cake. All the factors will drive the demand for SSD and a steady growth is expected.

Another less mentioned growth aspect is the rising tide of cloud computing. Corporations are rushing to build private or public data centers to meet internal and external demand. Data centers require arrays of disk drives. Currently traditional hard disk drives (HDD) are still cheaper than SSD and data centers are not moving around like iPads. And the HDD market is dominated by two companies that have double-digit weightings in the ETNs.

Western Digital (NYSE:WDC) is weighted 13.1% in SSDD and Seagate (NASDAQ:STX) weighted 12.2%. Combined together, they will control 80% HDD market once Western Digital completes its acquisition of Hitachi’s disk-drive business. Moreover, component makers such as Marvell (NASDAQ:MRVL) (7.87%) manufacture controllers that are critical parts for both SSD and HDD.

Yet a third growth aspect is the macroeconomic trend. Based on our sector rotation roadmap, an organic economic expansion is emerging. To be more specific, we are in Early Expansion phase, during which discretionary spending from both businesses and consumers often brings up technology upgrade. The entire technology sector, including SSDD, will benefit from the macro trend.

SSDD also has solid fundamentals. We consult our ETF ranking system to gain insight into which sector is likely to outperform and which sector is likely to underperform. The ranking system is based on valuation, financial condition, and return on capital and has predictive power. We observed that stocks with higher ranks had a strong tendency to outperform those with lower ranks over a period of one week. The data show that moving up 10 rank points translates to an extra annualized return of 1.7% in the past 10 years, if ranks range from 0 to 100. As a matter of fact, the S&P 500 returned a mere annualized 2.5% in the same period. For a brief understanding of our methodology, please read “ETF Ranking: A New Fundamental Approach That Drives Short-Term Return."

As of today, SSDD is ranked at 76, meaning its aggregated fundamentals are better than 76% percent of stocks in the market. An ETF ranked at 76 has an expected annualized return that is about three times the market return. The aggregated rank of the entire market should be 50 since it is generally an average of all stocks whose ranks range from 0 to 100. Because in the past 10 years 10 rank points translated to an extra annualized 1.7%, a stock ranked at 76 would have outperformed the market (ranked at 50) by 1.7% x (76 – 50) / 10 = 4.4% annually. Plus a market return at an annualized 2.5%, the total annualized return would have been 6.9%, which is about three times 2.5%, the market return in past 10 years. That said, historical returns do not guarantee future performance.

Mind you, SSDD and SSDL are not ETFs but ETNs, with which investors will be exposed to certain level counter-party risks. And recently UBS, the issuer of the ETNs, reportedly lost $2 billion as a rogue trader in its ETF desk engaged in unauthorized trade.

Another consideration is liquidity. Newly incepted ETFs do not have time to attract enough liquidity and will witness expanded bid / ask spread and heightened tracking errors. Nonetheless we think the Solid State Drive ETNs are good mid to long term buy and liquidity won’t matter too much.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.