Seeking Alpha

Fidelity Zero Total Market Fund Is Slightly Overvalued

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About: Fidelity ZERO Total Market Index Fund (FZROX), Includes: AAPL, AMZN, BRK.B, FB, GOOG, GOOGL, JNJ, JPM, MSFT, VTI, XOM
by: Ploutos Investing
Summary

FZROX’s portfolio of stocks consists of 2,500 U.S. stocks ranked by market capitalizations.

Top holdings in FZROX’s portfolio are companies with competitive positions over its peers.

However, these companies are slightly overvalued when compare to their historical average.

FZROX’s sales and cash flow growth rates appear to be lower than the S&P 500 Index’s sales and cash flow growth rates.

ETF Overview

Fidelity Zero Total Market Index Fund (FZROX) owns a portfolio of 2,500 U.S. stocks ranked by market capitalizations. The fund seeks to track the investment results of the Fidelity U.S. Total Investable Market Index. Most of FZROX’s stocks are giant-cap and large-cap stocks. Its top-holdings are also stocks with strong competitive position. However, these stocks are slightly overvalued. While an economic recession is likely not imminent, the average EPS growth rate in FZROX’s portfolio may decelerate due to a slowdown in the global economy. Therefore, the current risk and reward profile is not very attractive. We think investors can wait for a pullback before initiating a position.

Chart Data by YCharts

Fund Analysis

FZROX has similar sector weightings than other total stock market funds and S&P 500 Index

Unlike S&P 500 Index that focuses on the largest 500 U.S. stocks by market capitalization and Vanguard Total Stock Market ETF’s (VTI) 3,600 stocks by market capitalization, FZROX focuses only about 2,500 stocks by market capitalization. This is primarily due to the number of small-cap and medium-cap stocks that these ETFs hold. As can be seen from the chart below, S&P 500 Index holds almost no small-cap stocks and medium stocks only represent 10.43% of its portfolio. FZROX and VTI have similar weightings. However, FZROX has slightly higher giant-cap weighting than VTI and slightly lower medium and small-cap weightings.

FZROX

VTI

S&P 500 Index

Giant

47.17%

46.45%

55.33%

Large

29.65%

29.79%

34.23%

Medium

17.07%

17.30%

10.43%

Small

5.58%

5.62%

0.01%

Source: Created by author; Morningstar

In terms of sector weightings, FZROX, VTI and S&P 500 Index have similar sector weightings.

FZROX

VTI

S&P 500 Index

Technology

23.02%

22.90%

23.44%

Financials

15.80%

15.47%

15.67%

Healthcare

13.23%

13.24%

13.78%

Consumer Cyclical

12.15%

12.19%

11.89%

Industrials

10.59%

10.65%

10.15%

Consumer Defensive

6.99%

7.03%

8.09%

Energy

4.51%

4.49%

4.41%

Real Estate

3.91%

4.03%

3.75%

Communication

3.21%

3.16%

3.46%

Utilities

3.08%

3.16%

2.83%

Basic Materials

2.74%

2.74%

2.36%

Source: Created by author; Seeking Alpha Website

FZROX’s top holdings are stocks with competitive positions

FZROX’s top-10 holdings are companies with moats. As can be seen from the table below, 8 out of the top-10 holdings in its portfolio receive wide moat status according to Morningstar’s research. The remaining 2 receives narrow moat status. These 10 stocks represent nearly 18.06% of the portfolio. These are companies that either have products and/or services that are sticky to their customers (e.g. Apple (AAPL), Microsoft (MSFT, or Johnson & Johnson (JNJ)), enjoy strong network effects (e.g. Facebook (FB)), have or hold important key infrastructure assets (e.g. Exon Mobil (XOM)) that are difficult for its competitors to replicate.

as of 07/31/2019

Morningstar Moat Status

% of ETF

Microsoft (MSFT)

Wide

3.50%

Apple (AAPL)

Narrow

3.19%

Amazon (AMZN)

Wide

2.55%

Facebook (FB)

Wide

1.55%

Berkshire Hathaway (BRK.B)

Wide

1.33%

JPMorgan Chase & Co (JPM)

Wide

1.28%

Alphabet Class C (GOOG)

Wide

1.25%

Alphabet Class A (GOOGL)

Wide

1.21%

Johnson & Johnson (JNJ)

Wide

1.16%

Exxon Mobil (XOM)

Narrow

1.05%

Total:

18.06%

Source: Created by author

Its top-10 holdings appear to be slightly overvalued

While its top-holding stocks may have strong competitive positions, we want to make sure that stocks in FZROX’s portfolio are not expensive. Since it is challenging to look at each one of the 2,500 stocks that FZROX owns, we again look at its top-10 holdings. In the following table, we present readers with a quick comparison of these stocks’ forward P/E ratio with its 5-year historical average P/E ratio. As can be seen from the table below, these stocks have weighted average forward P/E ratio of 19.38x. This is nearly 1 multiple higher than their 5-year weighted average of 18.52x.

as of 9/15/2019

Forward P/E

5-year Average P/E

% of ETF

Microsoft (MSFT)

26.11

20.94

3.50%

Apple (AAPL)

16.89

13.89

3.19%

Amazon (AMZN)

47.62

No meaningful Value

2.55%

Facebook (FB)

19.05

28.66

1.55%

Berkshire Hathaway (BRK.B)

17.09

13.19

1.33%

JPMorgan Chase & Co (JPM)

11.40

11.33

1.28%

Alphabet Class C (GOOG)

21.46

21.76

1.25%

Alphabet Class A (GOOGL)

21.46

22.12

1.21%

Johnson & Johnson (JNJ)

14.31

16.38

1.16%

Exxon Mobil (XOM)

18.21

19.21

1.05%

Weighted Average

19.38

18.52

18.06%

Source: Created by author

Let us compare FZROX with VTI and S&P 500 Index. As can be seen from the chart below, FZROX’s forward P/E ratio of 18.14x is slightly lower than VTI’s 18.29x but slightly higher than S&P 500 Index’s 17.67x. However, FZROX’s sales growth rate of 5.69% is lower than S&P 500 Index’s 7.09%. Similarly, FZROX’s cash flow growth rate o 12.36% is also lower than S&P 500 Index’s 13.25%. Therefore, we do not think FZROX trading at a discount. In fact, it is slightly overvalued.

as of 9/15/2019

FZROX

VTI

S&P 500 Index

Forward P/E Ratio

18.14x

18.29x

17.67x

Price to Cash Flow Ratio

8.94x

9.12x

9.03x

Sales Growth (%)

5.69%

5.67x

7.09%

Cash Flow Growth (%)

12.36%

12.28%

13.25%

Source: Morningstar, Created by author

U.S. economy remains robust, and therefore, a recession may not be that imminent

The current economic cycle has been well into its 10th year and the party is still on. While the global economic growth rate appears to be decelerating due to global trade tensions, the U.S. economy is still relatively healthy. The unemployment rate is at a record low since 1969. In addition, U.S. retail sales of 0.4% in August 2019 was pretty good. While rate cut may still be needed, a recession is likely not imminent in this environment. However, earnings growth may decelerate due to a slowdown in the global economy since many stocks in FZROX’s portfolio have sizable businesses oversea.

Risks and Challenges

Economic recession

An economic recession can result in significant decline in revenues as consumers cut their spending on e-commerce and companies reduce their Internet ad spending. In addition, negative market sentiment in an economic downturn may result in valuation contraction.

Not a convenient ETF to buy

While Fidelity charges 0% management expense rate on FZROX, it is not possible to buy FZROX through your broker. The only way to buy this ETF is to open a Fidelity account. This is one major inconvenience of owning this ETF.

Investor Takeaway

FZROX provides another good way to invest in the entire stock market. However, we feel it is currently slightly overvalued. While a recession is not imminent, the current risk and reward profile is not particularly attractive. Therefore, we think a pullback will provide a better entry point.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.