For Tech Exposure, PowerShares QQQ ETF Is A Great Fit

| About: PowerShares QQQ (QQQ)
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By Robert Goldsborough

With the stock market enjoying substantial recent gains and many technology firms in particular having rebounded from the weakness they experienced during late 2011, all eyes are on the seemingly ubiquitous, device-making behemoth Apple (NASDAQ:AAPL). With Apple rising 33% since the start of the year, clearing a market cap of $500 billion, and hovering around a stock price of $540, the question for investors in Apple--and more broadly, for tech investors--has to be: Is there any more gas left in the tank, or is the sector fully valued?

Right now, the answer is that some very modest upside remains in the tech sector. And for those investors still interested in tech but wanting to hedge their bets and seek a low-cost, diversified option to avoid single-stock risk, we recommend PowerShares QQQ ETF (NASDAQ:QQQ), a passively managed exchange-traded fund that holds 100 of the largest nonfinancial stocks traded on the Nasdaq. So QQQ, also known as the Cubes, holds tech bellwethers such as Apple, Microsoft (NASDAQ:MSFT), and Google (NASDAQ:GOOG), along with some large-cap biotech names and a swath of tech-oriented consumer firms such as (NASDAQ:AMZN), (PCLN), and Netflix (NASDAQ:NFLX). In all, pure tech firms make up more than 68% of QQQ's assets.

A Sector That Has Outperformed the Broader Market
In recent months, the tech sector has rebounded after some stumbles in late December that suggested that IT demand might be slowing. Driving the December weakness--after a surprisingly high level of IT spending throughout the recovery up to that point--were troubling reports from several tech bellwethers, generally less confidence about business prospects, and even questions about reduced government spending on IT both in the U.S. and abroad.

Since December, however, a wide variety of factors have conspired to boost investors' confidence both about the market in general and about technology in particular. Sentiment clearly has shifted away from concerns about a recession, as a steady stream of mostly positive economic data has been reported. And investors generally are less concerned now about the sovereign debt crisis in Europe than they were several months ago. Among tech firms in particular, most companies--Google being a notable exception--posted fourth-quarter earnings results that exceeded expectations, suggesting that investors again are believers in tech demand, and that the issues late last year were merely short-term blips.

The market has responded in kind. For example, QQQ is up 7% in the last month and 18.5% over the past six months, compared with the broader S&P 500, which is up just under 5% over the past month and 13.3% over the past six months.

An Apple-Driven Rebalance That Didn't Change Much of Anything
QQQ tracks the Nasdaq-100 Index, which underwent a special one-time rebalancing last spring in an effort to reduce the overweighting in Apple and adjust the weightings of many other holdings as well. At that point, Apple's weighting in the index--and by extension, the ETF--fell from almost 21% down to 12%. Today, Apple's weighting has risen back up to a whopping 17% of QQQ. Probably the other significant change in QQQ is Microsoft's larger position than in the past. Prior to the special rebalance, the software giant comprised about 3% of the fund. Post-rebalance, Microsoft adjusted to about 8% of the fund, and today makes up more than 9% of QQQ.

What Kind of Upside Remains?
Despite QQQ's recent outperformance, we believe that the ETF remains attractively valued for investors interested in technology. Morningstar's equity analysts calculate estimates of fair value for hundreds of U.S. companies, and Morningstar's ETF Screener then aggregates and weights those values to arrive at an estimate of fair value for an entire ETF. Right now, QQQ is trading at 94% of fair value, meaning that some modest upside remains in this ETF. The fund is slightly more fully valued than U.S. large-cap ETF SPDR S&P 500 (NYSEARCA:SPY), which trades at 92% of fair value. However, the companies held in QQQ also offer slightly faster earnings growth.

A Compelling Price Tag
QQQ is a popular ETF with both retail and institutional investors, making it highly liquid. What's more, it charges a very inexpensive annual fee of 0.20%, which is in line with the expense ratios assessed by other large technology ETFs.

If You Want to Look Elsewhere ...
Of course, QQQ is not the only game in town. Investors seeking tech-only exposure can consider a wide variety of other options, including Technology Select Sector SPDR (NYSEARCA:XLK) (0.18% expense ratio), which also has a 17% weighting in Apple and--unlike QQQ--also holds telecommunications companies. Another relatively liquid option is Vanguard Information Technology ETF (NYSEARCA:VGT) (0.19% expense ratio), which also focuses on technology companies but holds a much more diverse portfolio of more than 400 firms. Even so, Apple makes up about 14% of VGT's portfolio, which also holds IT services companies (QQQ holds no IT services firms). A pure-play, broad large-cap technology ETF option is iShares Dow Jones US Technology (NYSEARCA:IYW) (0.47%), which holds more than 150 tech companies and has a nearly 20% weighting in Apple.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including BlackRock, Invesco, Merrill Lynch, Northern Trust, and Scottrade for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.