FIW: Still Expensive, But This Water ETF Is Flowing In The Right Direction

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The First Trust Water ETF holds 36 companies that derive a substantial portion of their revenues from the potable water and wastewater industry.Over the last two years, I have relied on fundamental ...

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Direction\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-06-08 03:13 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4698105-fiw-still-expensive-but-this-water-etf-is-flowing-in-the-right-direction><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>The First Trust Water ETF holds 36 companies that derive a substantial portion of their revenues from the potable water and wastewater industry.Over the last two years, I have relied on fundamental ...</p>\n\n<a href=\"https://seekingalpha.com/article/4698105-fiw-still-expensive-but-this-water-etf-is-flowing-in-the-right-direction\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"PSCI","symbol_name":"Invesco S&P SmallCap Industrials 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In previous reviews, I've noted issues with FIW's valuation, quality, and earnings momentum.FIW has shown improvement on these factors over the last year, and despite it offering solid growth potential, it trades at 23.25x earnings, a rich multiple for the Industrial sector.As a result, I've assigned a neutral \"hold\" rating to FIW, but I believe there could be an excellent buying opportunity in the months ahead if its valuation decreases.   Dougal WatersInvestment Thesis I last reviewed the First Trust Water ETF (NYSEARCA:FIW) on July 16, 2023, concluding that the water industry's supply chain challenges and the ETF's high valuation warranted only a \"hold\" rating. Since that article was published, FIW has lagged behind the Invesco Water Resources ETF (PHO) and the SPDR S&P 500 ETF (SPY) by 1.44% and 5.56%, respectively. Seeking AlphaI continue to look at FIW regularly because it could nicely complement Index funds like SPY. Still, FIW's 0.53% expense ratio is a significant detractor, and I only want to get involved with it when its fundamentals look too strong to ignore. That's the purpose of today's update, and I look forward to walking you through the latest numbers in detail below. FIW Overview Strategy Discussion FIW tracks the ISE Clean Edge Water Index, selecting 36 companies that derive revenues from the potable water and wastewater industry, specifically:  water distribution water infrastructure (pumps, pipes, valves) water solutions (purification, filtration) ancillary services (consulting, construction, marketing)  An independent committee determines what defines \"substantial,\" so readers should know it's not a pure play on water. At each semi-annual rebalancing in March and September, selections are assigned a security weight after being sorted by market cap, as follows:  Securities 1-10: 4% Securities 11-15: 3.5% Securities 16-20: 3% Securities 21-30: 2% Securities 31-36: 1.25%  The top ten holdings, totaling 39% of the portfolio, are listed below. This group includes most of the largest companies by market cap, including the recent Danaher (DHR) spin-off Veralto (VLTO), Ecolab (ECL), and Roper Technologies (ROP). Missing is IDEXX Laboratories (IDXX), the fourth-largest security by market cap but FIW's #15 holding. The stock has struggled YTD, down 10.67%, but it should become a top holding after the September rebalancing. First TrustPerformance Analysis Since June 2007, FIW has delivered a 451.29% total return with reinvested dividends compared to 252.28% and 389.93% for PHO and SPY, respectively. Annualized, it's about 1-3% more, and FIW's risk-adjusted returns (Sharpe and Sortino Ratios) are far superior to PHO, its most direct peer. However, we can see how water stocks are more volatile than the broader market, and this extra volatility wasn't always positive. FIW's downside risk-adjusted returns (Sortino Ratio) were 0.82 vs. 0.87 for SPY. Portfolio VisualizerThe above statistics describe 17 years of history, which can be challenging to draw conclusions from. Instead, I encourage you to view an ETF's long-term rolling returns chart, as it quickly highlights periods when FIW has succeeded and when it's struggled. For example, for the three years ending May 31, 2024, FIW's annualized returns lagged behind PHO and SPY by 0.08% and 1.41%, respectively. Portfolio VisualizerThis chart reveals the two water ETFs experienced a boom from 2011-2013 that was quickly followed by a crash in the subsequent years. FIW's returns were flat in 2014 (0.36%) and negative in 2015 (-10.01%), which management attributed almost entirely to the fund's composition that overweights the Industrial sector, writing in the annual report: The Industrials sector contributed the most to the Fund's relative underperformance against the benchmark. The Fund experienced -5.8% of drag due to its 48.3% greater allocation to the poor-performing sector. This is one small example of the risks investors face when investing in undiversified funds. Over time, it's still worked out well, but limiting it to a small percentage of your portfolio and getting in at a great price are important. That's my primary goal through fundamental analysis, but since I began coverage two years ago, I've discovered several weaknesses to justify buying over SPY. FIW Analysis Composition By Sector, Sub-Industry Before I evaluate those potential weaknesses, I want to highlight FIW's composition differences with PHO and SPY. As shown below, FIW has 56% allocated to Industrials, which is similar to PHO. MorningstarFIW holds stocks across 16 GICS sub-industries, as follows:  Industrials Machinery & Supplies & Components: 22.36% Water Utilities: 14.28% Environmental & Facilities Services: 9.21% Building Products: 8.63% Life Sciences Tools & Services: 7.24% Trading Companies & Distributors: 6.66% Construction & Engineering: 5.54% Electronic Equipment & Instruments: 4.53% Specialty Chemicals: 4.09% Application Software: 3.86% Health Care Equipment: 3.31% Research & Consulting Services: 2.87% Soft Drinks & Non-Alcoholic Beverages: 2.71% Multi-Utilities: 2.04% Commodity Chemicals: 1.50% Agricultural & Farm Machinery: 1.14%  PHO has no exposure to sub-industries #11, #13, #14, and #15, so arguably, it's less diversified than FIW. Finally, FIW is an efficient complement to SPY, as there is only a 0.75% overlap by weight. PHO's overlap with SPY is slightly more at 1.93%, but regardless, the takeaway is that water stocks likely aren't prominent in your portfolio. FIW and PHO are efficient choices. FIW Fundamental Analysis The following table highlights selected fundamental metrics for FIW's top 25 holdings, totaling 82.53%. This figure is lower than PHO's 94.75%, supporting the argument that it's better diversified. The Sunday InvestorHere are two additional observations: 1. Since my last review, FIW's estimated one-year earnings per share growth rate improved from 10.99% to 12.05%. In addition, its valuation metrics also improved. FIW trades at 25.49x forward earnings using the simple weighted average method and 23.25x using the harmonic weighted average method, which is close to what you'll see on websites like Morningstar. The fund also has a long-term (3-5 years) earnings growth rate of 10.56%, indicating it's a solid growth play for the foreseeable future. MorningstarStill, the valuation is elevated for ETFs in this sector. For example, the Invesco S&P 500 Equal Weight Industrials ETF (RSPN) and the Invesco S&P SmallCap Industrials ETF (PSCI) trade 4-6 points cheaper, and in RSPN's case, feature a similar 11.48% estimated one-year earnings growth rate. As I wrote in October 2022, water is expensive, and FIW's results since then did support diverting cash away from SPY. 2. Quality is typically low with this size segment. However, FIW's 7.09 sector-adjusted profit score, derived from Seeking Alpha Factor Grades, improved from the 6.68/10 score last year. Meanwhile, SPY's score has decreased from 9.43/10 to 9.32/10, so I'm pleased to see the gap shrink. In addition, FIW's 6.55/10 EPS Revision Score also improved from last year's 5.59/10 score, indicating Wall Street analysts are turning bullish. Previously, I highlighted downward earnings revisions for Advanced Drainage Systems (WMS), but the stock is up 18.42% YTD and has surpassed consensus earnings estimates for five consecutive quarters. Seeking AlphaInvestment Recommendation  FIW's fundamentals improved since my review last year, specifically on quality and valuation relative to SPY. However, it's still priced at a premium compared to other industrial sector ETFs, and I'm not ready to pay the fund's high 0.53% expense ratio unless I'm confident I'm getting in at a great price. Since that's not the case today, I've reiterated my neutral \"hold\" rating on FIW and plan to check back next quarter with another review. Thank you for reading.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2441809094"}