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Beat the Market With a Water ETF

- By Rupert Hargreaves

According to financial research provider Morningstar, over the past 10 years, the S&P 500 has produced an average annual total return for investors of 5% per annum. Over the same period, the First Trust Water (FIW) exchange-traded fund has produced an average annualized return of 8%, outperforming the wider market by 3% per annum with an annual expense ratio of 0.57%. Granted, the First Trust Water ETF was not launched until May 2007, so these figures are out by a few months. Nonetheless, they do present a clear picture.

An ETF to beat the market

The First Trust Water ETF has outperformed the S&P 500 over its lifetime. As water becomes more scarce, it is likely this will continue to be the case.

Water investing has become a hot new topic since it was revealed the "Big Short's" Michael Burry had gone all-in on the sector.

There are very few ways to play the water trend. The commodity is mostly owned by governments or private equity firms that have acquired water companies seeking lucrative returns from the bespoke assets. As water is a finite resource, the number of companies available to buy is limited.

Still, the First Trust Water ETF provides access to a market that investors would otherwise be unable to get into. If you are looking for a good way to invest in water and the water sector, this ETF could be the best bet.

With assets under management of $250 million, the First Trust Water ETF is not the largest ETF in the market, but it does not need to be. The expense ratio is 0.57% and the 30-day SEC yield is 0.54%. There are 37 holdings in the portfolio spread across different sectors, countries and markets.

Dissecting the holdings

The largest holding, coming in at 4.73% of assets under management, is IDEXX Laboratories Inc. (IDXX), the global market leader in diagnostics and information technology solutions for animal health and water and milk quality.

IDEXX is not a typical water investment, but it has all the hallmarks of a solid long-term buy. Over the past six years, the company has grown revenue at a compound annual growth rate of 7.8%, net profit has grown at 6.5% per annum and Wall Street analysts believe earnings per share are set to expand 20.3% this year and 15.3% in 2018. The company's return on capital employed has averaged 45% for the past six years, and IDEXX's average number of shares in issue has declined by 4.8% per annum since 2011 due to aggressive share repurchase plans. Unfortunately, a company of this quality does not come cheap. Shares in IDEXX currently trade at a forward price-earnings (P/E) ratio of 47.4 and an EV/EBITDA ratio of 30.9. Still, for such a defensive business at the forefront of water analysis, its shares are certainly worth paying a premium for.

The second-largest holding is a bit cheaper and more of a direct play on water. Companhia de Saneamento Basico do Estado de Sao Paulo or SABESP (SBS) is 4.56% of the portfolio and is a Brazilian water and sewage service provider. Unlike other Brazilian companies that have struggled with the country's economic problems over the past few years, SABESP has grown steadily since 2011, with revenue expanding from 9.9 billion real ($3.2 billion) to 11.7 billion real. Earnings have declined as the company has invested in its operations, with assets growing from 25 billion real to 33.7 billion real over the period. The shares trade at a trailing 12-month P/E ratio of 9.5.

The ETF's third-largest holding is Roper Technologies Inc. (ROP). This is more of a diversified play on water engineering and is, once again, a relatively expensive investment. The shares trade at a forward P/E ratio of 22.5 and earnings per share have grown steadily at 8.2% per annum since 2011.

Disclosure: The author owns no stock mentioned.

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This article first appeared on GuruFocus.