SCHG: Time To Buy The Dip In Big Tech

seekingalpha07-30

Erik Isakson The Schwab U.S. Large-Cap Growth ETF (NYSEARCA:SCHG) has more than tripled over the past decade by primarily being investing and overweight in the biggest and best technology companies on...

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Given the recent and relatively severe market rotation out of big-tech and into small-cap and value stocks (see graphic below), I am encouraging investors to consider slowly increasing their exposure to these high-growth strong free-cash-flow generating technology companies. Today, I will explain why SCHG is a BUY. Data by YCharts As can be seen by the chart above, over the past month, both the Vanguard Small-Cap Index Fund ETF Shares (VB) and the iShares Russell 2000 ETF (IWM) have significantly out-performed the SCHG and Nasdaq-100 Trust (QQQ) ETFs, both of which are highly weighted in the leading technology companies. However, this rotation appears to have much more to do with expectations that, finally, the Federal Reserve will begin cutting interest rates (likely in September) than it does any big decrease in big-tech earnings and/or big increase in small-cap earnings. That being the case, I consider the current rotation to have a fairly short half-life and for big-tech to reassert itself heading into the end of the year. To quote the great Yogi Berra, this is like \"déjà vu all over again\" for me. Back in the depths of the 2022 bear-market in tech stocks, I was pounding the table for investors to buy them considering their revenue growth, earnings growth, and free-cash-flow generation remained excellent throughout the nearly year-long sell-off. See SCHG: Time To Buy Tech Stocks. Since that article was published, SCHG went on to outperform the S&P 500 by more than 20%. So, let's take a closer look at the SCHG ETF today and see why investors should consider slowly increasing their exposure. We'll start with a look at the top-10 holdings. Top-10 Holdings The top-10 holdings in the SCHG ETF are shown below and were taken directly from the Schwab SCHG webpage, where you can find more information on the fund. Schwab As you can see from the graphic, the top-10 holdings represent what are arguably the most dynamic big-tech companies on the planet, with a relatively concentrated 58.9% allocation of the entire portfolio. That allocation includes a 40%+ weight in the top-4 holding alone: Microsoft (MSFT), Apple (AAPL), NVIDIA (NVDA), and Amazon (AMZN). The #1 holding with a 12% weight is Microsoft, which continues to be a strong #2 to Amazon with Azure - the company's cloud computing business. Indeed, in its FY24 Q3 (calendar Q1) report in April, revenue growth was 17% yoy led by a 21% increase in its Intelligent Cloud segment: Microsoft Margin expansion led to operating income (23%) and EPS (20%) that grew even faster than revenue. Quarterly free-cash-flow of $21 billion was up an impressive 18% yoy despite increased cap-ex spending on AI infrastructure build-out. Microsoft reports its Q4 and full-year FY24 earnings tomorrow (Tuesday). Apple is the #2 holding with an 11.9% weight. Apple has been perceived as being \"late to AI\". However, expectations for the roll-out and OS support for AI (\"Apple Intelligence\") into its new iPhones is expected later this year. The stock has been strong this year in anticipation that \"AI\" will boost sales. That said, it too has pulled back with the recent market rotation: Data by YCharts AI-chip leader Nvidia is the #3 holding with a 10.6% weight. In its Q1 FY25 report back in May, Nvidia continued to demonstrate robust growth: revenue of $26 billion rocketed 262% yoy and net income of $14.9 billion (57% of revenue) was up a whopping 628% yoy: Nvidia At the time, Nvidia reported continued strong demand for its GPU solutions:  Supply for H100 continued to improve; still constrained on the H200. The next-generation Blackwell chip was in full production and the company was working to bring up its system & cloud partners for global availability later this year. Demand for H200 & Blackwell was well ahead of supply; the company expects demand may continue to exceed supply well into 2025 (i.e., high margins will likely continue).  Nvidia currently trades with a forward P/E=41x. Yet, given the bullets above, I'd say it's worth the market premium. While Amazon is listed above as the #4 holding in the SCHG ETF with a 6.4% weight, note that - in aggregate - holdings in two classes of Alphabet stock - (GOOG) and (GOOGL) - equate to 7.6% of the portfolio, making it the true #4 position. Google apparently disappointed investors with its Q2 report last week, but not this shareholder. I was pleased with Google's $87.4 billion in revenue (+14% yoy), its 300 basis point increase in operating margin to 32%, its 31% increase in EPS to $1.89/share, its first $10+ billion quarter for Google Cloud (+29% yoy), and its free-cash-flow generation of $13.5 billion despite a significant increase in cap-ex. I am fine with Google growing cap-ex to invest in AI infrastructure because I am confident of the company's ability to monetize those assets across its leading franchises: YouTube, Google Cloud, and Search. And, if that was a \"weak quarter\", all I can say is: give me more! Broadcom (AVGO) is the #8 holding with a 2.5% weight. My followers know I consider Broadcom to be one of the best long-term investments in AI given its leading position in high-speed networking and the fact that its VMWare software has a partnership with Nvidia to enable it to support Nvidia GPUs with its full-stack enterprise virtualization software. That being the case, I expect Broadcom to continue growing its high-margin software business going forward. With respect to its semiconductor AI solutions and high-speed networking potential, note this quote during the Q2 conference call back in June when Broadcom CEO Hock Tan said: Talking of AI accelerators ... our hyperscale customers are accelerating their investments to scale up the performance of these clusters. And ... we have just been awarded the next generation custom AI accelerators for these hyperscale customers of ours. Networking these AI accelerators is very challenging, but the technology does exist today. In Broadcom, with the deepest and broadest understanding of what it takes for complex, large workloads to be scaled out in an AI fabric. Proof in point, seven of the largest eight AI clusters in deployment today use Broadcom Ethernet solutions. Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth. Sorry for the relatively long quote, but it is important that investors understand the big-picture with respect to the link between AI accelerators and the high-speed networking infrastructure required to keep them fed with low-latency, high-bandwidth data. In Q2, Broadcom grew quarterly revenue to $12.5 (+43% yoy) and generated $4.4 billion of free-cash-flow (36% of revenue). I expect FCF as a percentage of revenue to increase in the coming quarters to more \"normal\" and historical Broadcom levels as the company continues to digest the VMWare acquisition and generate higher profit with lower expenses (just like Hock Tan has done with every acquisition he has made). In summary, what all these companies have in common is the following:  Strong global brands. Strong financial returns and free-cash-flow generation. Excellently positioned for the future in terms of AI and the cloud. Strong balance sheets.  Performance The following graphic shows the long-term performance of the SCHG ETF:   Schwab As can be seen from the chart, the SCHG has a very impressive 16.3% average annual 10-year return. The chart below shows the 10-year total returns performance of the SCHG ETF as compared to those of the S&P 500 and the Nasdaq-100 as represented by the (VOO) and (QQQ) ETFs, respectively, as well as to in-category funds like the Fidelity Enhanced Large Cap Growth ETF (FELG) and the Invesco Large Cap Growth ETF (PWB): Data by YCharts As can be seen in the graphic, of the chosen funds only the Invesco Nasdaq-100 triple Q's has outperformed the SCHG ETF, which handily beat its peers and the S&P 500. Risks The SCHG ETF currently has a P/E = 37.5x, which is a significant premium as compared to the S&P 500 (28.6x). That said, in my opinion, the growth and free-cash-flow profiles of these leading tech companies are well worth the valuation premium. Presidential candidate Trump has threatened to impose new tariffs on China in the range of 60-100%. This would likely cause a significant bearish reaction in the technology sector. The expense ratio of the SCHG ETF is only 0.04%, making it very cost-effective for investors. The current market rotation could continue a while longer. That is why I am advising investors to scale-in slowly and to take advantage of market volatility to do so. Summary & Conclusion  The Schwab Large Cap Growth ETF, SCHG, has an excellent long-term performance track record and a very cost-effective expense ratio. The fund is over-weight the best and most dynamic technology companies on the planet, all of which have strong global brands, strong growth, and strong free-cash-flow generation profile and all are excellently positioned to benefit from long-term secular growth catalysts in AI and the Cloud. SCHG is a BUY. That said, my followers know that I have been actively managing my portfolio over the past few years in an effort to both simplify it by reducing the total number of holdings and to also, hopefully, increase performance. That being the case, I sold my position in SCHG some time ago and moved the proceeds in an existing position in the QQQ ETF.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":1,"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":"4.29.3","shortVersion":"4.29.3","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/2455071636"}