Investing in 2007 - part IV

In the previous articles, we looked at the different asset categories and the returns from these asset categories in 2006. The return from asset categories in 2006 is important as the current prices will tell us if the asset is a buy at current prices or not. In this section, we will look at the REITs and the large cap growth sector in US to see if they are buys at current prices. The analysis in this segment is limited to the sector as a whole as opposed to individual stocks. It is possible for the sector to be expensive and thus unattractive. At the same time, a stock in this category might be a buy because of the fundamentals.

First the vanguard REIT etf VNQ. The current yield for VNQ is 3.63%. Given that the REITs are required to return 90% of their income to the shareholders, the effective yield is 4%. The ten year bond is currently yielding 4.6% and is entirely safe. So, the REITs aren't looking attractive at the moment. Let us look at some more details to see how VNQ looks like.

As of 11/30/06, VNQ's equity characteristics were as follows. The P/E ratio was 49 with return on equity of 8% and projected earnings growth of -3.6%. The REIT ETF held 104 stocks altogether. Let us look how some of the top holdings for this ETF looks like:

SPG - Simon Property Group has a P/E of 59.
EOP - Equity Office Properties has a P/E of 40.
VNO - Vornado Realty Trust has a P/E of 37.
PLD - ProLogis has a P/E of 25.
EQR - Equity Residential has a P/E of 19.
ASN - Archstone Smith Trust has a P/E of 17.
BXP - Boston Properties has a P/E of 16.
PSA - Public Storage has a P/E of 67.
GGP - General Growth Properties has a P/E of 229.

As a group, the above equities have high P/Es and the stocks with lower P/Es have low dividend yields. Looking at the fundamentals of this sector, it is safe to stay away from this sector at this moment till the P/E and the dividend yield become more reasonable.

Looking at the large cap growth sector, let us take a look at VUG, the vanguard growth ETF. The growth ETF equities have the following characteristics as of 11/30/2006.

The ETF held 457 stocks altogether with a median market cap of 34.8 billion. The P/E of the ETF is 21.5 with a price to book ratio of 4 and earnings growth rate of 23.1%. The return on equity is 19.1% which is very respectable. Let us look at the top ten holdings from this ETF and their P/E ratios and growth prospects. The ten largest positions account for 21% of the ETF holdings.

MSFT - Microsoft Corporation has a P/E of 24.
PG - Proctor and Gamble has a P/E of 24.
JNJ - Johnson and Johnson has a P/E of 17.4
CSCO - Cisco Systems has a P/E of 27.
INTC - Intel Corpoation has a P/E of 21.
WMT - Walmart Stores has a P/E of 17.
GOOG - Google Inc has a P/E of 61.
PEP - Pepsi Inc has a P/E of 21.
IBM - International Business Machines has a P/E of 16.
AMGN - Amgen Inc has a P/E of 29.

As a group, the top ten holdings of this group are mixed. On the one hand there are fully priced stocks such as Google and on the other hand, there are low priced stocks such as WMT and JNJ with a bunch of stocks in between. It should also be noted that as a group, this sector is entirely dependent on growth to power the stock price. My bet for this group would be to do decently in 2007. The main reason being the top holdings of MSFT and INTC are expected to do well on the back of new product launches, CSCO is doing ok and the some of the low priced stocks may succeed in getting out of the negative publicity surrounding them. It is not possible to find the right time to get in but I would get in once the major indices have a correction from the current price points.

In the next segment, we will cover the large cap blend and value segments.