Amplify Online Retail ETF IBUY: Dangerous Valuation, Low Quality
This earnings season seemed to be one replete with precedents of rapid and ruthless wringing out of valuation excesses, as I observe.
The environment in which the outlook for growth stocks is clouded by higher interest rates that could rise much faster than initially expected is highly combustible. The market struggles to interpret the data releases, without too much thought pushing stock prices lower when financials surprise on the downside.
The Amplify Online Retail ETF (IBUY) is one of the hardest-hit growth-oriented exchange-traded funds, with a price drop of more than 21% since the start of the year.
IBUY is a mix of pandemic champions who have seen their market value increase thanks to changed shopping habits due to the lockdowns that have spurred the rise of e-commerce. Now most are in free fall, with Shopify (SHOP) being the prime example, with yet another Meta (FB) moment this year, but with a less devastating price drop in absolute terms. Yet the soft tips actually reduced SHOP’s price by almost 20% in less than a week.
Certainly, a contrary argument can be made here that the long-term trends shaping e-commerce are in place, thus a rare buying opportunity has arisen. Undoubtedly, there is always logic behind contrarian optimism, but I would opt for a neutral stance.
First, the scale of the problem can be felt immediately by looking at the ETF’s ratings summary: all is red. The combination is rather bleak, as IBUY is an expensive (the 65 bps ER), non-dividend and risky fund with worrying asset flow trends and simply dismal performance.
And second, while promising at first glance, investing in an online retail portfolio means being overexposed to expensive, low-return stocks. So, I think it’s best to stay on the sidelines.
IBUY follows the smart-beta EQM Online Retail Index. Essentially, the benchmark has a relatively broad approach allowing stocks from both developed and emerging markets (depending on a few liquidity and accessibility considerations) to compete for the spot if their market values are north of 300 million of dollars.
A voter must generate at least 70% of their sales from “traditional online retail, online travel or online marketplaces”. Heavyweights that generate less than 70%, although at least $100 billion, are also given the green light.
To avoid being overly dependent on a handful of the most generously valued companies, the index uses a modified equal weighting. Specifically, the index provider is content with non-US stocks eligible for inclusion, with one caveat: US stocks that are grouped into group one are assigned at least 75% total weighting. It’s an interesting approach to minimizing currency risk, I would say. Foreign stocks are in group two, where they are weighted equally, just like their US counterparts within their cohort.
The weightings are reassessed during the semi-annual rebalancing.
An index tracked by the ProShares Online Retail ETF (ONLN), IBUY’s closest peer, takes a somewhat similar approach, allocating ex-U.S. stocks just 25% of combined weighting, while also banning companies whose market value is less than $500 million. The main difference is that since the ingredient of market capitalization is also part of the mix, ONLN’s portfolio is extremely heavy, with Amazon (AMZN) accounting for more than a quarter of net assets (~26.4% in the index on February 18). The Amplify ETF does not have this flaw, with AMZN in 5th place (~2.5% weight) and the top ten holdings having a share of around 26%.
Another peer, the Global X E-commerce ETF (EBIZ), tracks the Solactive E-commerce Index, which also uses a modified market capitalization weighting, but with a cap of 4%/0.3% to avoid the maximum heaviness.
Returns the policy was able to provide
IBUY has delivered clearly astronomical gains in the past, but on limited timeframes, with near zero possibility of replicating such an outstanding performance in the future.
First, let’s compare its returns to the S&P 500 ETF (SPY) and the Nasdaq 100 followed by the Invesco QQQ ETF (QQQ). The time period covered is from May 2016 (IBUY was launched in April 2016) to January 2022.
IBUY beat SPY, but with higher standard deviation and high risk to boot. QQQ results were more attractive, with a CAGR over 3% higher and a perfect Sortino ratio above 2.
Obviously, the supercharged phenomenal alpha in 2020 was getting progressively thinner in 2021 before completely evaporating in 2022.
To add a little more color, the following chart shows how SPY, QQQ and IBUY have performed this year. As usual, the Invesco S&P 500 Pure Value (RPV) ETF has been added for better context.
Next, the group of closest peers, with the aforementioned ONLN and EBIZ. The period analyzed is much shorter, December 2018 – January 2022, due to the EBIZ launched in November 2018.
Despite having a higher expense ratio of 65 basis points compared to EBIZ’s 50 basis points and ONLN’s 58 basis points, the fund outperformed both, albeit with a higher standard deviation.
Either way, the trio still underperformed SPY and QQQ, with the softness of the first few weeks of 2022 to blame.
With such a steep decline from an all-time high, has a contrarian opportunity emerged? Let’s evaluate a few factors.
As of February 19, IBUY managed a portfolio of 79 stocks, with Expedia (EXPE) being its top holding with a weighting of around 3.5%.
As expected, most are US companies, almost 75% at the end of 2021, as shown on the fund’s website, with China taking second place with a 6.5% weighting. Alibaba (BABA) can certainly be found in the mix, but only around 0.8% by weight. Other emerging market stocks include Ozon (OZON), a Russian internet retailer with Nasdaq-listed ADS.
All three echelons of the stock market are present, with many small caps like Groupon (GRPN), large caps like eBay (EBAY), and over $1 trillion like AMZN.
Now the factors. The key consideration in a contrarian thesis is that the valuation is more or less adequate, with no intolerable risk of further contraction in multiples. Quant data will help us assess this.
~80% of IBUY’s holdings have a Quant rating (I adjusted for tickers this time) and only 14% have Sport Value characteristics (a valuation rating of B- or better). 51% of the portfolio is very poorly valued (D+ ratings at best), despite the e-commerce multiples which are gradually correcting in 2021 and this year. The scope for further decline therefore remains large. Interestingly, growth factor exposure is significant, but not ideal: only ~35%.
Then IBUY clearly has a quality problem.
With 34% of stocks having profitability ratings of D+ and worse (nearly the same share has strong earnings), the fund doesn’t look like a quality investor’s safe haven.
Digging deeper, the chart below summarizes total capital returns and EBITDA margins for around 80% of holdings.
While there are extremely profitable companies in the mix, like Copart (CPRT), which sits in the top right corner with a 20% ROTC, most score rather poorly, unable to generate even meager EBITDA. .
I intentionally removed Jumia Technologies (JMIA) and ContextLogic (WISH) to improve chart readability. Both have horrible results, with an EBITDA/ROTC margin of -120%/-31% and -31%/-121%, respectively.
The following chart combines cash flow and net income margins.
The picture is again rather pessimistic, as almost 22% of companies have exceeded their cash flow (and therefore have not been able to cover capital expenditure) and around 32% are not profitable.
The pandemic has created an enabling environment for e-commerce players, accelerating trends that have been accelerating for years. With an apparent decline and investors turning away from growth stocks, IBUY is becoming much riskier than before.
The long-standing thesis based on the assumption that online commerce will continue to dominate is of course valid. The problem is that too rapid expansion has been taken into account, while the quality is precarious. In short, it is better to stay on the sidelines.