MXI: Materials Dashboard For August

This monthly article series shows a dashboard with aggregate industry metrics in materials. It is also a top-down analysis of sector exchange-traded funds, or ETFs, like Materials Select Sector SPDR ETF (XLB), iShares U.S. Basic Materials ETF (IYM), and other funds whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italics describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield ("EY"), Sales Yield ("SY"), Free Cash Flow Yield ("FY"), Return on Equity ("ROE"), Gross Margin ("GM"). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY, and FY are medians of the inverse of Price/Earnings, Price/Sales, and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non-available when the "something" is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for packaging in the table below is the 11-year average of the median Earnings Yield in packaging companies.

The Value Score ("VS") is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score ("QS") is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance.

Current Data

The next table shows the metrics and scores as of last week's closing. Columns stand for all the data named and defined above.

Value and Quality Chart

The next chart plots the Value and Quality Scores by industry (higher is better).

Evolution Since Last Month

The most notable change is a deterioration in value score for mining/metals.

Momentum

The next chart plots median returns by subsector.

Interpretation

Construction materials are the best-ranked subsector regarding both value and quality scores. Chemicals and packaging are close to their historical baseline in valuation. Quality is above the baseline for packaging, and it is close below it in chemicals. Mining/metals seem heavily overvalued after the value score fell sharply in the last 2 months.

Fast Facts on MXI

iShares Global Materials ETF (NYSEARCA:MXI) started investing operations on 9/12/2006 and tracks the S&P Global 1200 Materials Index. It has 102 holdings and a 12-month trailing yield of 3.40%. The total expense ratio is 0.41%, whereas XLB charges only 0.10%. The heaviest country in the portfolio is the U.S., with over 40% of asset value.

The portfolio is quite concentrated: the top 10 holdings, listed in the next table, weigh 35.6% of asset value, and the top 2 names are over 6%. However, it is more diversified than XLB, which has over 65% in the top 10 holdings and 20% in the largest position.

* U.S. ticker for convenience. The fund usually holds shares in primary exchanges. Ratios from Portfolio123

iShares Global Materials ETF has underperformed benchmark XLB since inception by almost 3 percentage points in annualized returns (see next table). It also shows a higher risk measured in maximum drawdown and volatility (standard deviation of monthly returns).

Data calculated with Portfolio123

However, MXI has slightly outperformed its peer in the last 12 months:

In summary, MXI is an ETF for investors seeking diversified global exposure in basic materials. It currently holds 102 global stocks, including large and mid-caps, whereas XLB invests in 32 large U.S. companies. Nonetheless, past performance is underwhelming. Investors who are concerned by risks related to the concentration of capital-weighted ETFs in their top holdings may prefer the Invesco S&P 500 Equal Weight Materials ETF (RSPM).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a chemical company with an Earnings Yield above 0.0422 (or price/earnings below 23.70) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers, with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. It is a rotational model with a statistical bias toward excess returns in the long term, not the result of an analysis of each stock.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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