How To Find The Best Style ETFs

Finding the best ETFs is an increasingly difficult task in a world with so many ETFs to choose from.

You Cannot Trust ETF Labels
There are at least 38 different large cap value ETFs and at least 216 ETFs across all styles. Do investors need that many choices? How different can the ETFs be?

Those 38 large cap value ETFs are very different. With anywhere from 30 to 1,351 holdings, many of these ETFs have drastically different portfolios, which creates drastically different investment implications.

I am sure that large cap value ETFs hold many of the same big stocks such as International Business Machines (IBM), Chevron (CVX) and 3M (MMM). However, investors need to know what else those ETFs hold before they can say they have done their due diligence.

The same is true for the ETFs in any style as each offers a very different mix of good and bad stocks. Some styles have lots of good stocks and offer lots of good ETFs. The opposite is true for others while some styles lie in between with a fair mix of good and bad stocks.

For example, large cap value, per my 4Q Style Rankings report, ranks fourth out of 12 styles when it comes to providing investors with quality ETFs. Large cap blend ranks first. Small cap value ranks last.

The bottom line is that investors cannot trust ETF labels or names. They do not tell you what you are getting when you buy an ETF.

Paralysis By Analysis
I firmly believe ETFs for a given style should not all be that different. I think the large number of large cap value (or any other) style of ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 1,351 stocks for one ETF.

Any investor worth his salt knows that knowing the holdings of an ETF is critical to finding the best ETF.

The Danger Within
Why do investors need to know the holdings of ETFs before they buy? They need to know to be sure they do not buy an ETF that might blow up. Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. As Barron’s says, investors should know the Slow and Steady Wins the Race ”, I explain how XOM has created enormous value for shareholders over the last quarter century. Buying Exxon Mobil (XOM) now is one of the easiest calls in the market these days. With superior cash flows, a cheap valuation and one of the strongest competitive positions in the business world, it is hard to make a straight-faced argument against owning this stock anywhere below $100. My model shows the stock is worth $140 if one assumes profits never grow from 2011 levels, i.e. the “no-growth” value of the stock. This stock offers nice risk/reward too.

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Disclosure: I own XOM. I receive no compensation to write about any specific stock, style or theme.

Written By: David Trainer