Could Salesforce and Adobe Help Power the Low-Cost Vanguard Tech ETF to an All-Time High?

Investment management firm Vanguard offers a variety of sector-based exchange-traded funds (ETFs) that mirror the performance of all 11 Global Industry Classification Standard stock market sectors. The Vanguard Information Technology ETF (VGT +0.85%) has a mere 0.1% expense ratio and a minimum investment of just $1, making it an easy way to dip your toes into the tech sector at a low cost.

The semiconductor industry has been the main driver behind the tech sector's sustained rally. But software giant Salesforce (CRM +0.23%) just blasted to a new all-time high. And Adobe (ADBE 0.48%) is up over 15% from 52-week lows from May.

Let's find out if a boom in software stocks could help take the Vanguard Tech ETF to new heights and some risks worth considering before investing in top software stocks.

Image source: Getty Images.

How enterprise software is investing in AI

Talking about the tech sector without mentioning artificial intelligence (AI) is impossible. After all, Nvidia (NVDA +1.97%) has become the most valuable company in the world because of the massive growth potential of AI. More computing power is needed to power AI models, and Nvidia is on the cutting edge of making graphics processing units and associated hardware for data centers.

But for the AI narrative to last, companies must develop and profit from AI tools. The pressure is on enterprise software companies like Microsoft (MSFT +1.62%), Salesforce, and Adobe to prove that AI spending is worth it.

Microsoft's research and development spending has soared as it invests in AI solutions. AI assistants called Copilots are embedded in several applications, such as Microsoft 365, GitHub, Azure, and more. On Oct. 21, Microsoft unveiled new autonomous agents for business processes such as sales, finance, and supply chains.

Salesforce has touted the benefits of its Agentforce suite of AI agents. Agentforce could become a lucrative value add for Salesforce's industry-leading customer relationship management platform and Salesforce-owned Tableau and Slack.

Adobe has been developing many AI tools, such as its generative AI text-to-image tool Firefly and an AI Assistant for Adobe Acrobat that can give summaries of PDFs.

Despite their potential, AI developments have not yet led to blistering growth for Salesforce and Adobe. Adobe's margins have stalled, and Salesforce only recently began generating consistent operating income. Neither company has grown its top line at an impressive rate in recent years. Salesforce's trailing-12-month revenue is up just 37.7% in three years, and Adobe's is up only 32.7%.

Enterprise software companies that rely on software-as-a-service (SaaS) business models must balance innovation without reducing their customer base. For example, the Adobe Creative Cloud All Apps business plan is $89.99 per month per license. Suppose Adobe improves its suite of apps by so much that it can charge $135 per month per license. But because each user can accomplish so much more, an Adobe business customer decides it only needs 10 licenses instead of 20. Adobe would end up with higher revenue per license but lower overall sales. In other words, its innovation would lead to a crack in its business model.

The biggest question facing enterprise software companies is how they will modernize the SaaS business model in the age of AI so that they aren't so dependent on the number of licenses. The uncertainty facing software companies is one reason why semiconductor companies are leading the tech sector, not software. Software companies face the challenge of monetizing AI without jeopardizing their existing business models, whereas a company like Nvidia benefits from overall AI adoption. So, Nvidia is a safer and more straightforward way to bet on AI than a specific enterprise software company.

Breaking down the Vanguard Tech ETF

Even if Salesforce and Adobe continue to surge higher, they wouldn't be able to impact the Vanguard Tech ETF meaningfully. As you can see in the following table, a whopping 44.6% of the Vanguard Tech ETF is invested in Apple, Nvidia, and Microsoft -- illustrating the sheer size of these giants compared to other tech companies.

Data source: Vanguard.

It's also worth understanding how the ETF is allocated by industry. As you can see in the following table, around a third of the ETF is now in semiconductor companies. The semiconductor industry's influence on the tech sector extends far beyond Nvidia.

Data source: Vanguard.

For example, diversified semiconductor, hardware, and networking company Broadcom alone makes up a larger share of the ETF than Salesforce and Adobe combined.

A better way to target software stocks

The Vanguard tech ETF is a great way to get broad-based exposure to the tech sector, but it isn't the best way to invest in application and infrastructure software companies. Investors interested in top enterprise software companies like Oracle, Salesforce, Adobe, ServiceNow, and Intuit may prefer to simply buy shares of those individual names or take a closer look at software ETFs like the iShares Expanded Tech-Software Sector ETF (IGV +1.43%).

By focusing exclusively on software companies and leaving out chip stocks and big hardware companies like Apple, investors get way more exposure to enterprise software names. For example, the ETF has a 9.4% weighting in Salesforce, which is more than five times higher than the Vanguard Tech ETF.

In sum, Apple, Nvidia, and Microsoft have gotten so big that they will continue driving the Vanguard Tech ETF. Investors who already own these three companies and don't want further exposure may want to consider investing in other tech stocks or ETFs instead.