A 26% Tech S&P 500 Isn't as Bad as It Sounds

Twitter's (TWTR) big day is making Twitter shareholders very happy, and some S&P 500 investors very nervous. In this episode of MarketFoolery, host Mac Greer and analysts David Kretzmann and Matt Argersinger explain why the S&P's massive weighting in tech isn't as alarming as it first seems, and what other funds and ETFs investors can research for more diversified market exposure.

Also, they hit on a few of the market's biggest news items: how this S&P business will affect Twitter's long-term future, what it means for Starbucks (SBUX -1.02%) that Chairman Howard Schultz is finally stepping away from the business, and why the unsexy, unloved banking sector is one that long-term investors won't want to miss.

A full transcript follows the video.

This video was recorded on June 5, 2018.

Mac Greer: It's Tuesday, June 5th. Welcome to Market Foolery! I'm Mac Greer, and I'm joined in studio by Motley Fool analysts Matt Argersinger and David Kretzmann. Gentlemen, welcome!

Matt Argersinger: Hey, Mac!

David Kretzmann: Hey! 

Greer: How are you feeling?

Kretzmann: Feeling good.

Greer: Good!

Argersinger: Caps are on the verge.

Greer: Caps are on the verge. For those of you not following the NHL playoffs, that's our Washington Caps. They're getting close to winning the Stanley Cup. I have to admit, I'm about a once-every-20-year hockey fan, and I've been watching it.

Kretzmann: [laughs] This is one of the 20 years?

Greer: Oh, my gosh! I mean, the thing that amazes me is, they are doing all of that while skating.

Argersinger: Yes, that's true. I've lived in D.C. for about 15 years, and I really never thought, in any time living here, that we'd see a parade. And we're this close.

Greer: Isn't it incredible?

Argersinger: I don't want to jinx it, though.

Greer: Ovechkin, that's all you have to know. If you don't know anything about hockey, just say Ovechkin. Ove, right?

Argersinger: Ove, yeah.

Kretzmann: I have no idea what you're talking about. I'll just go with it. Is he a player?

Greer: He's the best player, he's really good. OK, let's talk about some other action going on. We're going to talk about Twitter joining a very exclusive club. Twitter on quite the roll lately, we'll get to that. Then, Matt, I know you think there's an area of the market that's underappreciated and undervalued, we're going to get to that. 

But let's begin with Starbucks. Big news here. Shares down a bit on Tuesday on news that chairman Howard Schultz is stepping down. David, when we think Starbucks, we think Howard Schultz. He's been with the company for 36 years. He was CEO from 1987 to 2000, and then he was CEO again from 2008 to 2017. For those of you scoring at home, 11 stores in the 80s. Starbucks had 11 stores. Today, 28,000 stores in 77 countries, market value of around $78 billion. David, you're a shareholder!

Kretzmann: I am.

Greer: How are you feeling about Howard Schultz stepping down?

Kretzmann: I'm actually feeling good about this. I think, in comparison to last decade, when he basically stepped back from his day-to-day activities with the company, the company is in stronger shape today competitively, financially. This is a company generating close to $3 billion in free cash flow annually, still a lot of expansion opportunities around the world. They're continuing to make progress with things like food and iced beverages and the premium Reserve Roastery brand. 

All in all, I think Starbucks is a nicely diversified company, a lot of expansion opportunities. New CEO Kevin Johnson, over the past couple of years, has shown that he really appreciates the soul of Starbucks. And obviously, that's something unique to Schultz and the culture he created with the company. I think the team at the helm certainly doesn't want to go through what happened to Starbucks a decade ago, when Schultz took a step back from the company. The company really lost that focus on the culture and the ethos that was so critical to differentiating themselves from McDonald's or the other coffee providers out there. All in all, I think the company is still in good shape. I continue to be a happy shareholder.

Argersinger: To borrow something from Warren Buffett, I really think Howard Schultz made the snowball, and it's just rolling downhill right now. I think Kevin Johnson is running with it. By all accounts, the culture that Schultz has established, especially the momentum they have in China, is just a great hand-off. I don't see how the business significantly slows down now that Schultz is stepping down. I think he set the baseline that the company is running with, and it should do just fine.

Greer: Guys, what strikes me, I started at The Motley Fool back in 1998. Tom and David interviewed Howard Schultz on our then AM radio show that year. He had just written his book, Pour Your Heart into It. Even back then, he was about something bigger, this idealism. You both alluded to the fact that really, Schultz has this reputation as being incredibly socially responsible. His idea that the CEO should be a moral leader. One quote jumped out at me. He said he wanted to achieve "the fragile balance between profit and conscience."

Kretzmann: Don't hear a lot of CEOs saying anything quite like that. I think most of us here at The Fool, probably all of us, I hope most or all of us, are fans of that idea of conscious capitalism. It's not all about maximizing profits, but in the long run, you're actually probably going to be better off if you're trying to uplift all your stakeholders -- whether it's the environment, the community, shareholders, employees, customers, all the different stakeholders in there. I think Starbucks, thanks to the vision of Howard Schultz, was really ahead of its time by adopting that kind of mindset, really as soon as Howard Schultz stepped into the leadership role at the company. 

That's also why I'm optimistic about the company going forward. I think they have the valuable experience of going through a leadership transition that didn't go all that well last decade. Schultz and everyone else involved, on the board and executive management, they've known this was coming for a while. Schultz, I think last year, he informed the board, like, "Yeah, I want to continue to basically take a step back from the company." I have to think they've worked through a lot of the scenarios. I think Kevin Johnson has proven, with his response to the incident in Philadelphia last month, that if anything, the company is over correcting and now allowing anyone to use the Starbucks bathroom, even if they're not a customer. I think the social conscience of Starbucks continues to be in good shape.

Argersinger: Yeah. If you need an example of a company that creates tremendous value for shareholders while doing all these things, while paying employees very well, doing the best you can for customers, being good on the environment, being socially conscious and investing in your community, Starbucks is the greatest example. I hope it's an example that other corporate leaders can take, and say, "We don't have to have a business," as David said, "totally geared toward maximizing profits." While that's important, mostly for shareholders, I think there's a lot of ways to create additional value for your brand, for your company, by doing all these other things, as well. And no one has probably proven that better than Howard Schultz.

Greer: Let's get to the elephant -- or the donkey, if he's a Democrat, or a Republican -- in the room.

Argersinger: [laughs] Nicely done!

Greer: Thank you! Do we have any doubt that Schultz is running for president?

Kretzmann: Very little.

Greer: He's running.

Kretzmann: Almost guaranteed.

Greer: He won't say it, but he's running.

Argersinger: Right. I was probably 50-50, even going into last night and today. Then he gave a couple of interviews earlier today, one with Andrew Ross Sorkin of CNBC, which I thought was great. Yeah, I think there's little doubt now that he's going to be pretty engaged in public life. Whether that necessarily leads to a presidential run, I think it does, but, he's going to be out there, he's going to be a candidate of some kind.

Greer: I'm going to tiptoe through the policy here, because we're not a political show. Whatever you think about the current occupant of the White House, I think he's been fairly successful at branding -- both building a brand and branding others. I think it would be a fascinating debate if you have Schultz and Trump, and you have Trump saying, basically, "What do you know about building a global brand?"

Argersinger: There you go. I think Schultz has a pretty good answer for that. [laughs] 

Greer: Yeah, a very good answer! I will be fascinated. I bet he'll get a nickname in the next few days.

Argersinger: Yeah, we'll see what Trump tweets. I think Trump needs to get a little credit here, because he did break the mold in this way, in the sense that a non-establishment politician, mostly, and a businessman from the business world, can be the president of the United States. I think that's interesting. Here we are, the United States of America, we're probably the bastion of capitalism, and we really haven't traditionally had a business leader, certainly a person who spent most of their career in business, rise to that level, until Trump. I think he's opened the door in a lot of good ways.

Greer: Yeah. And this morning, Matt, we were talking Schultz giving interviews, talking about the debt, the deficit. I'm like, wow! I haven't heard that in a while! That's, like, Ross Perot speak. 

Argersinger: Thank goodness!

Greer: You have to go back a while. It is worth noting that Schultz's story is amazing. He grew up dirt poor in New York. That'd be the other thing, you'd have two New Yorkers fighting it out. He was the first guy in his family to go to college. We were talking, if you want to win a bar bet this weekend, if you want to impress your friends, or if you need a pick-up line, if you're just desperate for a pick-up line, go up to someone and say, "You know, Howard Schultz isn't the founder of Starbucks." Right, Matt?

Argersinger: That's right. For some reason, the media, or certainly the conventional wisdom, is getting this wrong. The media gets it wrong many times. He is not actually the founder of Starbucks. He joined the company. I want to say the first store opened in 1971 in Seattle. And it was 12 or 13 years before, I think, Schultz even joined the company. He came in as an investor and as a person who was involved in the marketing. Now, he built the company to where it is today. There is no doubt about that. The Starbucks that you see today, which is a global, dominant retail concept, he founded that. But he is not the founder of Starbucks.

Greer: If that's not a conversation starter, I don't know what is!

Kretzmann: The first coffee concept, at least on the West Coast, was Peet's, which now is a much smaller company. I remember ten years ago or so, we had people on our discussion boards comparing Peet's Coffee vs. Starbucks. I think at the time, Peet's was a $500 million company or so. They ended up getting bought out. Anyway, in its current form, I think it's fair to say that Schultz is the founder. But if you're getting technical, that's a good bar bet.

Argersinger: One good last thing, I was talking to Chris Hill this morning. Chris and I are both from New England. We were thinking, Schultz could make a good presidential candidate, but, you know, I don't know how well he's going to do in the New England states. You have the Dunkin' Donuts!

Greer: That's a good point!

Kretzmann: The loyalists!

Argersinger: Right! [laughs]

Greer: I like Starbucks, I'm not a shareholder, but one of my biggest beefs with Starbucks is, I do find it a bit pretentious to have to learn a different language just to order my coffee. Here's what I want: I want to go in and say, basically, "I want a small, a medium, a large or a jumbo." That's what I want. And I know, it's this Italian vibe or whatever, but don't give me the venti stuff. That's where I'm more team Dunkin'. And I think that, if Schultz is going to run for president, you can't be using the word venti. You cannot. Do we agree?

Kretzmann: Maybe that'll be his nickname, something making fun of the Starbucks lingo.

Greer: Oh, that's true!

Kretzmann: Trump has to be thinking of something now.

Greer: Oh, he's working on it. I'm starting the clock on the nickname. I think, by Saturday, we'll have one.

OK, guys, let's switch gears and talk Twitter. Shares of Twitter hitting a three-year high on news that it's being added to the S&P 500. It will replace Monsanto. Matt, what does that mean for investors?

Argersinger: Well, it doesn't really mean much, except that Twitter, by being added to the S&P 500, is getting a big boost, because that means now, going forward, ETFs and index funds who track the S&P 500 are essentially forced to buy shares.

Greer: That's something! You say it doesn't mean much, that's a big boost!

Argersinger: Well, it doesn't mean much for the business in the long-term. But, hey, index representation is always a great thing. It certainly means that you've risen to somewhere as a corporation. It's kind of prestigious to be added to the S&P 500. 

But, Twitter in general, over the last 12 to 18 months, it's been a tremendous run for this company. All credit to Jason Moser, our podcast colleague, because he's really the one, when we were running Million Dollar Portfolio and elsewhere, pounding the table and saying, "You have to think bigger, longer-term about this platform and what it means." I think, now, the momentum is really justified. You have a business that, certainly from an active user base, is gaining a lot of momentum. Then, I think from, we're going to learn pretty soon, an ad-buying perspective, I think, whether you call whatever happened to Facebook a fallout or whatever, but I think there is some market share gains being had by Twitter. Especially, not just with what happened to Facebook, but how Facebook is changing the way it approaches its social network. Emphasizing friends, family, relationships, less news, media. I think Twitter has been the brand for that kind of engagement. And I think it's just getting increasingly more relevant.

Argersinger: I have to give credit to Jack Dorsey, because he's really turned around the sentiment at the company. It's interesting. If you actually look at the statistics, financially, from a revenue or free cash flow perspective, Twitter hasn't actually gained that much ground over the past year. Over the past year, the stock is up about 118%. Revenue is just up 4%. Free cash flow is up 14%. So, the stock has more than doubled even though the financial performance really hasn't changed meaningfully. This is really a case where investors are willing to basically assign a premium valuation to Twitter, which they hadn't been willing to do for three years. Right now, the price-to-sales ratio is about 11.6X. That's really bringing it back to where it was toward the end of 2015. This is really just a case where investors, I think, are getting comfortable with the narrative that Dorsey and company are telling with the company, and they're willing to assign a higher valuation that they hadn't been willing to in quite a while.

Greer: Guys, we got an email on the subject of Twitter and the index. It begins, "With Twitter being added to the S&P, isn't the S&P now too tech-heavy? Also, isn't there a financial requirement to just be listed on the S&P? With everyone taking Warren Buffett's advice and just investing in the S&P, I'm just afraid that if anything happens in the tech sector, everyone's investment would plummet. Can you recommend any other indexes, ETFs, or mutual funds to diversify one's portfolio? Thanks, Walter." He also says that he loves the show. Thank you, Walter, and thanks for listening to the show. What about that? Is the S&P too tech-heavy? Let's tackle this.

Argersinger: Sure. Well, thanks, Walter, for the great set of questions. If you look at the S&P 500 today, right now, the index is about 26% tech. The technology sector is roughly 26% of the index. That's by far the largest sector. The second-highest sector is financials at 14%, healthcare at 14%, and consumer discretionary at 13%. So, you have this big tech sector that's gobbling up more than a quarter of the index. 

But step back for a moment. If you dig into the details behind that, it gets a little more interesting. For example, let's just start with Twitter. Is Twitter actually a tech company? Is Facebook a tech company? I tend to look at those companies and say, maybe they're more media, entertainment, that kind of thing. Why are people engaging? I mean, there's a lot of technology behind the platforms. But, I think you can ask the question right there. 

Looking at, for example -- digging more into the technology sector -- MasterCard, Visa, PayPal are in the tech sector of the S&P, as well. Now, PayPal might make a little sense. But, MasterCard? Visa? I think if you asked most investors, they'd probably say, "Shouldn't those be in the financials sector?" Here's another interesting one: Amazon is not in the tech sector of the S&P, it's actually in the consumer discretionary part, it's in the retail sub-sector. That kind of makes sense to me. But then, eBay is in the technology sector for the S&P. 

Walter, my point here is, I wouldn't get too hung up on these sector weightings. I think there's a lot nuance that goes into how these companies get categorized. The tech sector being 26% of the S&P, if you really dig in, there are a lot of what I would call non-tech companies that are actually part of that weighting.

Greer: And how about the financial requirement he asked about? Is there a financial requirement to be listed on the S&P?

Argersinger: There is. I looked at it. I don't know all the requirements, but one of them is a market cap of at least $5.3 billion. I'm sure that's going up every year. You have to be headquartered in the U.S. Most of the outstanding shares for the business have to be held in public hands. They can't be privately held or held by insiders. I think there's some requirement, it's either six months or a year after a company IPOs, so a company can't IPO and then the next day get added to the S&P, there has to be some amount of time. And there are a few other requirements that I can't list off the top of my head.

Greer: And then, any recommendations for other indexes, ETFs, or mutual funds?

Argersinger: Sure. I'd say, Walter, one place to start, if you like the S&P 500 and what that offers you, look at ticker RSP. That's the S&P 500 equal-weight ETF. You're not overweight the tech sector, for example. You're equal-weighting all 500 stocks in the S&P 500. It's a very cheap ETF, as you might imagine. It's RSP. Actually, if you go back about ten years, the RSP has actually outperformed SPY, which is the popular traditional S&P 500 ETF. That's just one place to start.

Greer: Guys, let's wrap up. We just had our big annual member meeting. First, I want to give a shout out to our listeners, to our members. We had so many great conversations. I hesitate to name names. I'm going to name Richard and Joni in North Carolina, for starters, and then, all the other great listeners who came up and talked to us, and told me that they listened to the show while they were walking their dog or taking a long run. I just want to say thank you to all of our loyal listeners and our members. It's an absolute joy, and I mean that in all sincerity, it's a joy, and it's a privilege to get to do this show for all of our members. So, first of all, just a shout out to all of you. 

Kretzmann: Absolutely.

Greer: Matt, along those lines, I know last week, at our member event, you were talking about some stocks, maybe not the sexiest stocks --

Argersinger: No.

Greer: -- but stocks that were a little unloved, a little unappreciated, not necessarily big tech names, but some stocks that you think may present opportunities for investors.

Argersinger: Yeah. Actually, we just talked about the technology sector and financials and things like that. Well, if you look at banking ... we don't talk a lot about banks on this show, and they're not really represented in the stocks that we follow or recommend here in The Fool universe.

Greer: Unloved.

Argersinger: Very unloved.

Greer: Wells Fargo.

Argersinger: Yeah, Wells Fargo, great!

Kretzmann: Oof, boy!

Argersinger: But, I presented this at FoolFest. It's interesting to me, and I hope it's interesting to at least some of our listeners. There are almost 5,000 banks in the U.S. 5,000 separate banking companies, FDIC-insured institutions, here in the U.S. It's a huge number. You compare that to, say, how many auto companies we have, which is a handful; or how many big pharmacy companies that we have, it's a handful. But here, we have this industry, this banking industry, where there's 5,000 separate banks. 

It started to occur to me a few weeks ago, as we heard about the potential rollback of Dodd-Frank. And it's not really potential, it's happening. Most significantly in the rollback of Dodd-Frank is, they're going to raise the systemically important financial institution cap, which was at $50 billion --

Greer: Wow! OK, say that again.

Argersinger: Systemically important financial institution cap. It's basically the Fed's way of saying, "You have this amount of assets, so you have higher regulations, more scrutiny, you're subject to those annual stress tests." The cap on that was $50 billion in assets. That's going up to $250 billion. What that means is that a lot of banks now are going to have a lot less regulation. If you have $250 billion in assets, you're one of, say, a dozen banks in the U.S. that has that amount of assets. Really, it's only about the big banks. Now you have all the banks under that size that not only face less regulation, less costs, have also more leniency in terms of lending and investments that they can make, and I think that's going to accelerate the amount of consolidation that we're seeing in the banking industry. If you go back just five years ago, there were 6,000 banks. Today, there are 5,000. That's just five years. That means a lot of small and mid-sized banks are getting gobbled up every day. And a lot of these banks are very undervalued by, say, traditional, historical financial metrics.

Just to name a few banks that I've looked at that, that I think offer compelling opportunities: Bank of the Ozarks, ticker OZRK; there's a company called Eagle Bancorp, ticker EGBN; West Bancorp, ticker WTBA; Bank of Internet, ticker BOFI. I know these aren't household names. But I feel like you could do a lot worse than buying either a basket, or maybe, say, a regional bank ETF, to really capitalize on what I think is going to be, it's not going to be a home run trend, but I think it's a trend where you can probably make a lot of money over the next several years.

Kretzmann: I've tended to be more skeptical of banks -- maybe not skeptical. I just really don't know much about banks, so I've stayed away from them. Tying this back to our previous conversation about the S&P 500 and index funds, the Canadian market, where I've been focusing more of my time so far this year, is dominated by the big banks. The S&P TSX Composite, which is really the comparable index to the S&P 500, just in Canada, it's made up of 250 companies, the same idea, 250 of the bigger companies in Canada -- 65% of that index is made up of financials, with financials being the biggest category, along with energy and materials. Only 4% is in technology. It's a much different landscape, as far as the index goes in Canada. It's actually a similar makeup in Australia. 

Outside of the U.S., you have to be careful recommending people buy an ETF or an index fund, because you probably don't want to have a ton of exposure to financials, energy, and materials, which is what you would get if you bought that S&P TSX Composite. So, in general, with our Canadian services, we've tended to shy away from financials and the banks, because there's already so much exposure to that in the Canadian markets. We've tended to avoid that. But, I'd be curious if there's any sort of similar dynamics that you're talking about up in Canada. I don't know, but I should look at it.

Argersinger: I'm glad, DK, that you brought up Canada. I think, in Canada, and you might know this, I want to say there are less than ten banks.

Kretzmann: I think so.

Argersinger: And, you go to most European countries, Germany, for example, there's just a handful of banks. And here we are in the U.S., and for some reason, we have thousands and thousands of banks. [laughs] And I just feel like, we have 5,000, do we need five banks? Well, maybe. But, I just feel like there's going to be a lot of consolidation in the industry. It's not exciting, but if you're interested in making money like I am, I think it's someplace to look.

Kretzmann: Another company that's sort of played into that trend that I've only looked at a little bit, but I know some analysts here follow, is Q2 Holdings, which essentially provides software-as-a-service to those smaller regional or local banks. A lot of different ways that you can play into that tailwind.

Greer: On that note, let's wrap it all up with my favorite question, my desert island, completely arbitrary, totally unfair -- I don't know about your food and drink situation. What I know is that you're on a desert island for the next five years, and you have to buy one of these three investments, and you have to hold it: Starbucks post-Howard Schultz, who is not the founder, by the way; Twitter; or, let's say, a regional bank ETF.

Argersinger: Great! OK. Five years. Hmm.

Kretzmann: I'll kick it off. I'm going to go with Starbucks. I think the company will continue to do well, but within five years, Howard Schultz may very well be president, and he could rescue me off the island.

Greer: Wow, interesting!

Argersinger: That's great! I really like that.

Greer: If Howard Schultz -- if, if, if -- if he got elected president, do you think, does that have implications for Starbucks, either good or bad?

Kretzmann: I doubt it would have a dramatic impact. I think people who enjoy going to Starbucks will continue to go, people who are avoiding Starbucks already probably aren't any more likely to go because Schultz is president. I think it'll even out.

Argersinger: Another quick take on Starbucks, too, I would say there's a chance now, not necessarily because Howard Schultz is stepping away, but I've always thought of Starbucks as that perfect Warren Buffett, Berkshire Hathaway investment.

Greer: Interesting!

Argersinger: Maybe not as a total acquisition, because it's a large company. Even for Berkshire, that'd be taking a pretty big bite. But at least as a 10-20% position for Berkshire Hathaway ... and maybe Buffett's always thought it's expensive, sure, but in terms of quality businesses that he's looking for --

Greer: I want to get to your desert island pick, but now that we're on this --

Argersinger: Oh, I threw a wrench in things. [laughs] 

Greer: What about Costco? I always thought Buffett would want a piece of Costco.

Kretzmann: Yeah! Especially when he was allegedly trying to invest $3 billion into Uber. Like, if you're going after Uber, buy a few billion dollars' worth of Starbucks shares, or even Costco! Why not?

Argersinger: Costco, I agree, it makes a lot of sense.

Greer: So, back to your desert island.

Argersinger: Back to my desert island. Since you put the five-year constraint on, I'm actually feeling pretty good about that regional banking ETF, or, similarly, a basket of small-to-mid-size quality banks. I think you could do pretty well, I think you'll beat the market with a package like that. So, I'm going there.

Greer: OK. Well, we have given you plenty to talk about. If you're out and about tonight or this weekend, you can talk, what, regional banks, you can talk about the composition of the S&P, you can talk Canadian index funds --

Argersinger: You can impress someone by saying, "Howard Schultz is not the founder of Starbucks," and how all these media outlets got it wrong.

Greer: And then you can blame us when you just hear the crickets, when you just get a lot of blank expressions. You can say, "Those guys guaranteed me that was money!"

Kretzmann: I think we can drop the mic after this episode. This is just excellent.

Greer: [laughs] Matt, David, thanks for joining me!

Kretzmann: Thanks, Mac!

Argersinger: Thanks, Mac!

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! We will see you tomorrow!