SOXX Vs. QQQ: Time To Consider Heavier Bets On Tech

Aug. 05, 2022 6:24 PM ETInvesco QQQ ETF (QQQ), SOXXNVDA, SPY, COST, PEP29 Comments12 Likes

Summary

  • Many investors are familiar with the Invesco QQQ ETF and use it as a convenient vehicle to gain exposure to the tech sector.
  • However, many investors are unaware that QQQ is not a pure-tech play, probably not even a primary tech play.
  • Stocks in information tech represents less than 50% of its asset, a minor majority.
  • This article, therefore, compares QQQ to other pure-tech ETFs such as the iShares Semiconductor ETF so investors have a broader range of options.
  • There are good reasons to consider betting heavier on tech now, given their valuation correction and quieter volatility.
  • I do much more than just articles at Envision Early Retirement: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

A man stands making a cross gesture with his arms while standing on a seesaw with heavier casino chips on another side.

Gearstd/iStock via Getty Images

Thesis

Recent price corrections have brought tech valuations to a more reasonable range. The iShares Semiconductor ETF (NASDAQ:SOXX) has historically been traded at a premium relative to the overall market. For example, back in March 2022, SOXX was trading at a P/E of about 31.5x and SPDR S&P 500 Trust ETF (SPY) at about 26.5x according to Yahoo Finance data. However, recent corrections have brought SOXX P/E to the current level of 15.45x, about a 17% discount from the S&P 500’s 18.4x.

And you will see next that the discount from the NASDAQ 100 index, represented by the Invesco QQQ ETF (NASDAQ:QQQ), is even larger. To wit, SOXX suffered a total loss of 18.6% YTD and QQQ about 22% as you can see from the following chart. Combined with earnings changes, the valuation of SOXX now stands at 15.45x and QQQ at 22.01x, a discount of almost 30%.

Besides the valuation compression, the volatility has also become much quieter recently, adding another reason for considering a heavier bet on the tech sector. As you can see from the second chart below, the volatility index has subdued substantially YTD, decreasing from the 30+ level routinely seen at the earlier part of the year to the current level of 22.4x. To provide broader context, a volatility of 30 is at the top 93% percentile of historical volatility. While 22 is at about 71% percentile. The major reason for the quieter volatility is Fed’s recent rate movements and comments, which are consistent with market expectations and also provide clarity for the near term. And as detailed in our earlier article, when volatility is high, it’s a good idea to hunker down and vice versa.

Against this backdrop, we will look at the pros and cons of SOXX and QQQ more closely next.

Chart, line chart, histogram Description automatically generated

Seeking Alpha

volatility

Yahoo Finance

SOXX vs QQQ: basic information

QQQ needs little introduction. It is one of the most popular funds tracking the Nasdaq-100 Index. However, as aforementioned, many investors are unaware that QQQ is not a pure-tech play because the NASDAQ 100 index tracks the largest NON-FINANCIAL companies listed on the Nasdaq and many of these companies are not tech companies. I will table this for now and come back to this point later.

SOXX, in contrast, is a pure tech play completely concentrated in the semiconductor sector. As detailed in the fund description:

The iShares Semiconductor ETF seeks to track the investment results of an index composed of U.S.-listed equities in the semiconductor sector. It provides exposure to U.S. companies that design, manufacture, and distribute semiconductors and targeted access to domestic semiconductor stocks. It is used to express a sector view.

Graphical user interface, application Description automatically generated

Source: ETF.com

SOXX vs QQQ: Past performance and risks

Both the SOXX and QQQ funds have delivered handsome returns in the past as you can see from the chart below. SOXX has delivered an annual return of 10.12% since its inception in 2022, and QQQ has delivered a slightly higher CAGR of 11.5%. Both outperformed the S&P 500 by a good margin of about 2% to 3%.

When compounded over the past decade, such an alpha has accumulated into a sizable difference in total return. With dividends reinvested, SOXX has delivered a total return of 720% and QQQ more than 930%, far higher than the S&P 500’s 525%.

Although the downside is their price volatilities. We’ve already seen a glimpse of their price volatility in the short term in the previous section already in the past year. As you can see in the long term, both SOXX and QQQ have suffered much larger volatility than the S&P 500 too. And SOXX in particular has suffered by far the largest volatility. In terms of standard deviation, it's 27% is almost double that of the SP 500 (14%) and has also been higher than QQQ by about a whole 8%. In terms of worst-year performance, SOXX suffered a 51% loss (which will take more than a 100% rally to breakeven), which was 10% more than QQQ and 14% more than SP 500. And finally, in terms of maximum drawdown, SOXX’s 62% maximum drawdown (which takes a 163% rally to break even) is truly nerve-wracking. In contrast, both QQQ and SP 500 were in the 50% range.

And next, we will see that the root cause of the volatilities is in their fundamental indexing methods.

Chart, line chart Description automatically generated

Portfolio Visualizer

SOXX vs QQQ: More concentrated bet on Tech

As aforementioned, QQQ tracks the largest NON-FINANCIAL companies listed on the Nasdaq and many of these companies are not tech companies. As you can see from the chart below, information technology represents 49.8% of QQQ’s total assets, followed by communication services at 17.7%, and consumer discretionary at 14.9%. Admittedly, some of the companies in communication services and consumer discretionary are also tech companies. Nonetheless, information technology only represents a minor majority of the farm. Note that QQQ also holds a good portion of consumer staples, healthcare, industrials, and utilities.

Graphical user interface Description automatically generated

SOXX and QQ fund fact sheets

SOXX, in contrast, is a pure tech play. The fund is completely invested in the tech sector, especially the semiconductor sector. As you can see, it invests more than 79.1% of its total assets in semiconductor stocks and more than 20.6% in semiconductor equipment. Furthermore, its holdings are also more concentrated. SOXX holds a total of 32 stocks and QQQ about 100.

You can also see the concentration and composition more vividly by looking at their top ten holdings. One of their top 10 holdings overlaps: Nvidia (NVDA). But NVDA represents an 8.3% allocation in SOXX, in contrast to only 3.28% in QQQ. Also note that QQQ’s top holdings include stables like Costco (COST) and PepsiCo (PEP), while all SOXX holdings are semiconductor stocks.

To me, this is key for SOXX’s long-term performance. It places concentrated bet one of the most innovative sectors: information technologies. For this reason and the current valuation, I see favorable odds for SOXX to keep outperforming S&P 500 in the long term. I also see good odds for it to outperform QQQ too, as to be detailed next.

But again, before we turn the page, investors need to be aware of the volatility risks and to pick the right fund for their timeframe and risk tolerance.

Graphical user interface, chart, application Description automatically generated

Source: ETF.com

SOXX vs QQQ: valuation comparison

As aforementioned, SOXX has historically been traded at a premium relative to both S&P 500 and QQQ because of its growth potential. However, recent price corrections have brought its valuation to a discount. SOXX’s current P/E of 15.45x is ~17% discounted from the S&P 500. And as the next table shows, the discount from QQQ is even larger.

The price-to-earnings ratio of SOXX is 15.4x only, below QQQ’s 22.0x by about a whopping 30%. Other metrics paint the same picture. The price-to-cash flow ratio of SOXX is 19.5x, below QQQ’s 22.8x by about 15%. And price-to-book value ratio of SOXX is 7.13x, below QQQ’s 8.93x by about 20%, despite SOXX’s higher ROE of 46% vs 40% of QQQ. Finally, do not be alarmed by SOXX’s higher price-to-sales ratio. Its price-to-sales ratio of 6.23x is higher than QQQ by about 35%, but its net margin is higher by 90%.

Table Description automatically generated

Author

Final thoughts and risks

There are good reasons to start considering the tech sector now. QQQ has never been a bad choice with its low fee, broad market representation, and excellent liquidity. However, more aggressive investors with a long timeframe might want to consider SOXX also given the valuation correction and the quieter volatility ahead. SOXX has historically enjoyed a valuation premium over the overall market. But its current is ~17% discounted from the S&P 500 and about 30% from the QQQ.

Finally, risks. If you recall from an earlier chart, SOXX charges an expense ratio of 0.4%, and QQQ charges a lower expense ratio of 0.2% only. The extra fee will always create a drag on SOXX (0.2% per year). Also note that SOXX also has a much higher turnover ratio than QQQ (32% vs 8.9%), which might have tax implications for some accounts.

Graphical user interface, application Description automatically generated

Seeking Alpha

Join Envision Early Retirement to navigate such a turbulent market.

  • Receive our best ideas, actionable and unambiguous, across multiple assets.
  • Access our real-money portfolios, trade alerts, and transparent performance reporting.
  • Use our proprietary allocation strategies to isolate and control risks.

We have helped our members beat S&P 500 with LOWER drawdowns despite the extreme volatilities in both the equity AND bond market.

Join for a 100% Risk-Free trial and see if our proven method can help you too. You do not need to pay for the costly lessons from the market itself.

This article was written by

Sensor Unlimited profile picture
4.23K Followers
Proven solutions for both high income & high growth with isolated risks

** Disclosure** I am associated with Envision Research

I am an economist by training, with a focus on financial economics. After I completed my PhD, I have been professionally working as a quantitative modeler, with a focus on the mortgage market, commercial market, and the banking industry for more than a decade. And at the same time, I have been managing several investment accounts for my family for the past 15 years, going through two market crashes and an incredible long bull market in between. 

My writing interests are mostly asset allocation and ETFs, particularly those related to the overall market, bonds, banking and financial sectors, and housing markets. I have been a long time SA reader, and am excited to become a more active participator in this wonderful community! 


Follow

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Recommended For You

Comments (29)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.