Brand recognition brings fame to many companies, but exchange-traded funds (ETFs) don't often become household names. One exception might be the Invesco QQQ Trust (QQQ +1.31%), which focuses on long-term growth trends and leans heavily on the top stocks in the Nasdaq Composite.
The ETF has trounced the S&P 500, nearly doubling its performance over the past decade. Returns that good will earn a reputation. The fund has even shown strength in the market's recent turbulence. While the S&P 500 and the Nasdaq have fallen 7% and 15% from their respective highs, the Invesco QQQ has fallen 8%. In other words, it's outperformed during good times but held up well when things get tough.
But could that change? The fund's strong performance might not last if Wall Street starts panicking. Here is why investors should use caution moving forward.
The fund is stuffed with megacap stocks
For those unaware, an ETF is a basket of stocks lumped together and traded under a single ticker symbol. It's a great tool to invest in a diverse range of stocks without having to go out and buy a bunch of individual stocks yourself. The Invesco QQQ has been a big winner over the past decade, mainly due to its focus on the market's biggest and best technology companies.
QQQ Total Return Level data by YCharts.
Today, the Invesco QQQ's 10 largest holdings include a laundry list of compounders, including:
- Apple
- Microsoft
- Amazon
- Nvidia
- Meta Platforms
- Tesla
- Alphabet
- Broadcom
- Costco Wholesale
Together, these stocks represent a combined 49% of the fund. So, while the fund holds a total of 101 holdings, these top nine companies (Alphabet counts as two because it has two share classes) drive the funds' overall direction more than anything.
Why that could be a problem
Below, I've listed these top holdings from the highest to lowest weighting (Apple at 11% to Costco at 2%). You can see each stock's forward P/E ratio, what analysts estimate long-term earnings growth could average, and the resulting PEG ratio, which compares the P/E to expected earnings growth to give each valuation some context.
| Stock | QQQ Weight | Forward P/E | Long-Term Growth Estimate | PEG Ratio |
|---|---|---|---|---|
| Apple | 11.02% | 27 | 10.5% | 2.6 |
| Microsoft | 9.56% | 30 | 12.7% | 2.4 |
| Amazon | 5.24% | 58 | 37.5% | 1.5 |
| Nvidia | 4.45% | 42 | 33.1% | 1.3 |
| Meta Platforms | 3.83% | 24 | 22.1% | 1.1 |
| Tesla | 3.33% | 77 | 23.8% | 3.2 |
| Alphabet (A & C shares) | 6.41% | 24 | 17.3% | 1.4 |
| Broadcom | 2.94% | 20 | 11.9% | 1.7 |
| Costco Wholesale | 2.18% | 35 | 10% | 3.5 |
source: Chart created by the author.
When looking at the PEG ratio, anything at 1 or less is generally seen as attractively valued for the growth you might get, and I'll often accept a ratio up to 1.5 since I'm a long-term investor. Again, that's my personal preference. The point is that the stock gets more expensive the higher the ratio is.
You can see that Apple and Microsoft, which combine for nearly 22% of the fund, are quite expensive given their expected earnings growth over the long term. Some attractively priced components, such as Meta Platforms and Nvidia, are smaller weights and don't sway the fund as heavily.
The potential problem is that Apple and Microsoft can drag the fund down if they begin selling off harder. These blue chip stocks might be safe havens for investors, but even they could fall if investors panic sell. So far, Apple and Microsoft are only 9% and 10% off their highs, but things could get worse if investors begin losing confidence and selling.
What should investors do?
Just because the fund is vulnerable doesn't mean worst-case scenarios will happen. But the fund has had an extraordinary run over the past decade, and that's set up the situation the Invesco QQQ finds itself in today. Investors must at least recognize the risk in such a top-heavy fund, especially when valuations are stretched like they are today.
Investors can protect themselves by diversifying their portfolios away from big tech if they hold the Invesco QQQ already. You don't necessarily need to sell your Invesco QQQ shares if you own them; remember what makes up most of the fund. For example, having the Invesco QQQ, Apple, and Microsoft among your top holdings might mean you're taking on more risk than you realize.
If you're looking at buying shares in the fund, waiting might be wise. You can also look at the fund's holdings to go bargain shopping for companies that trade at attractive prices. Meta Platforms, Nvidia, and Amazon stick out as some potential candidates.
