The last two earnings season have seen a familiar pattern play out: companies of all shapes and sizes are consistently beating Street estimates on earnings, but falling short on revenue forecasts. In many cases, revenue is coming out either flat or even down compared to the same period in the prior year. There’s a growing list of companies that fit this description, including Merck, Eastman Chemical, Starwood Hotels, and AT&T this week alone (AAPL was one of the few companies that flipped this scenario, beating on revenue but falling short on the earnings side) [see Free Report: How To Pick The Right ETF Every Time].
These earnings reports have generally allowed markets to hold their year-to-date gains, as investors continue to give primary focus to EPS and less weight to revenue. But many believe it is setting the stage for steep declines ahead. While earnings can be given a short term boost through cost-cutting and other tricks, it is difficult to maintain a positive long-term outlook without meaningful growth in top line revenue. Revenue can be seen as a leading indicator of earnings growth; disappointing sales figures now have the potential to translate into disappointing earnings and cash flow down the road [see also Ex-U.S. ETFdb Portfolio].
Time For Revenue Weighted ETFs?
Recent trends may make revenue-weighted ETFs an interesting play now. The concept behind these funds is simple; they include all the components of broad-based cap-weighted indexes (such as the S&P 500), but determine the individual allocation made to each stock based on top line revenue and not the total value of the equity [try the Free ETF Analyzer Tool].
Revenue-weighted strategies will generally overweight companies with low price-to-sales ratios, and underweight those with high sales multiples. But in the current environment, there will be another nuance to these strategies; as rebalances occur, these portfolios will shift towards the relatively few companies that are managing to grow revenue and away from those that have been showing flat or declining revenue growth , even if they continue to post solid profits (i.e., those companies that may have discouraging leading indicators).
If you’re looking for an easy, rules-based way to overweight the few companies posting solid revenue growth in the challenging current environment, revenue-weighted ETFs may have some appeal [for more actionable ETF investment ideas, sign up for the free ETFdb newsletter]:
- RevenueShares Large Cap Fund (RWL, A-): Holds the components of the S&P 500, meaning that it has perfect overlap with cap-weighted ETFs such as IVV or SPY.
- RevenueShares Small Cap Fund (RWJ, B-): Holds the components of the S&P SmallCap 600.
- RevenueShares Mid Cap Fund (RWK, B-): Holds the components of the S&P MidCap 400.
- RevenueShares ADR Fund (RTR, B): Holds the components of the S&P ADR Index.
- RevenueShares Financials Sector Fund (RTW, n/a): Holds the financial stocks of the S&P 500.
Of course, these revenue-weighted products are still very much a “risk on” trade, as they offer exposure to a relatively risky asset class (U.S. stocks) that could see significant declines if markets head south.
Disclosure: No positions at time of writing.
- Talking Revenue-Weighting, Alpha-Generating ETFs With Sean O’Hara
- Are Your Cap-Weighted ETFs Leaders Or Laggards?
- Revenue Weighted ETFs Continue Impressive Run
- Weighting Methodologies: An ETF Report Card
- Revenue-Weighted ETFs: A New Twist On an Old Drink