QQQ ETF: Collection Of Best Ideas (2024)

Summary

The NASDAQ (National Association of Securities Dealers Automated Quotations) is synonymous with technology, volatility, and high returns. It was not always this way but since the great financial crisis (GFC) or great recession, the Nasdaq 100 (NDX) has beaten the S&P 500 (SPX) with technology companies that continue to innovate, grow, and dominate the investment ecosystem. To this end, I took a deeper look into the current portfolio of the Invesco QQQ ETF (NASDAQ:QQQ) and found better-than-expected growth offset by valuations. Fortunately, as is the case with many passive indexes, the cream rises i.e. the best stocks get bigger and replace or dislodge others while the mature companies stagnate and get pushed out into value land.

Performance

There are several NASDAQ indexes that an investor may choose from via funds or ETFs, to track. The NDX or the 100 largest non-financial stocks, the Composite (COMP) with over 3,500 stocks that include everything listed on the exchange and is 30% larger than the NDX, and the Nasdaq 100 equal weight (NDXE) that was introduced in 2005.

As can be seen in the charts below the performance of the QQQ, which tracks the NDX, jumped during the DOT COM but did not recover until well after the GFC. While many market pundits may attribute this to zero rates and a sort of golden market era, the underlying stocks in this index also produced superior growth i.e., via innovation and technological breakthrough much of which surfed the benefits of the internet and are still doing so today. The SPX did well as it incorporated the tech stocks and as technology increased productivity at the more agile old economy companies. The COMP and Equal Weight lagged and kept losing ground, which is how the indexes are designed.

QQQ Consensus Upside

I gathered consensus price targets for all of the ETFs holdings and calculated an upside potential of 8%. Not exactly what growth and risk-taking investors may have assumed. The near-term problem is not necessarily in the weights of low upside Apple (AAPL), Nvidia (NVDA), or Broadcom (AVGO) since the equal weight upside is also 8%. These are sell-side /broker estimates which, as I have experienced, can change rapidly as companies meet, beat, disappoint, and guide the market. The AI growth phenomenon has resulted in many upward revisions not envisioned a year ago. The biggest upside is with Warner Bros. (WBD) at 52% with Marriott (MAR) the most downside at -7%.

Revenue Growth and Margins

The QQQ has over 11% revenue growth and increasing net margins according to the consensus data. On an equal-weight basis growth and margins are lower, suggesting that the overweights are there for a reason. Growth figures should not be taken at face value given that many companies have weak results in 2023 on post-pandemic growth normalization i.e., overearning. What is key is risking margins on productivity gains and pricing power. Amazon (AMZN) in particular may see a substantial margin gain according to the consensus.

EPS Growth

Using consensus estimates I calculated a 21% EPS growth rate for the YE24-25 period. The QQQ portfolio has a far higher EPS growth rate than its Revenue growth would suggest. This is primarily due to increasing margins as already mentioned as well as share buybacks. The other factor, for some companies, is a low 2023 base given what I call earnings normalization post-pandemic. The high EPS growth also needs to be adjusted for the base effect and in some cases, I used a 3-year average growth vs the YE24-25 period. I believe it’s a more conservative approach. The QQQ lives up to its growth reputation with many holdings estimated to grow ESP by over 40%.

Valuation

The market frequently points to high valuation as a case for reducing stock exposure, especially in a still high-rate environment where the risk-free of 4% to 5% posed a barrier to riskier stock exposure. However, a few things occurred due to the Fed rate hiking cycle that may support continued equity exposure. The first is that the safe bond, fixed income, or bond proxies such as REITS, Preferred shares, and BDCs all suffered as badly, denting the appetite for safer assets. The second is that despite the rising rates many companies, especially in tech, continue to grow and innovate, and finally the cash that did move to money markets or CDs may look for higher returns/risk when the Fed begins to cut rates.

The QQQ may look expensive from an absolute PE perspective at 30x YE24 estimates, but relative to EPS growth it trades at 1.8x PEG. While this is not cheap it is not far from most other sectors and the S&P 500. I would venture to say that there is a greater probability of the QQQ becoming cheaper via higher EPS growth than due to declining share prices. That said, one may be enticed to cherry-pick the best ideas according to a low PEG, such as Meta (META), NVIDIA, Marvell (MRVL), or Take-Two (TTWO) for example.

Conclusion

I rate the QQQ a Buy. On the positive side, the portfolio's top weights seem to have high growth and almost reasonable valuation while the index should rotate to the best companies over time. Valuation is not cheap, but component stocks should grow into them according to consensus and the bond or risk-free alternatives may not provide the same long-term return once the Fed easing cycle begins. Think of the QQQ as a collection of the best ideas.

Ricardo Fernandez