ETF Options for Last Week’s Hot Stocks

Welcome to the first of an exciting new weekly offering for InvestorPlace readers. Every Monday, we will take five stocks covered by our writers in the past week and find ETFs that hold those stocks. By buying an ETF instead of the stock, you gain exposure to the stock while maintaining diversity and the liquidity of trading on an exchange.

As always, when finding ETF alternatives for specific stocks, the aim is to select a fund that has a decent position in the stock but also casts a wider net and is reasonably inexpensive to own.

InvestorPlace Assistant Editor Kyle Woodley started out last week by recommending iconic luxury brand Ralph Lauren (NYSE:RL). Woodley believes that despite a pricey stock, the brand is too strong to ignore. He’s right — any investor interested in retail apparel long-term must own Ralph Lauren stock. If you’re worried about its lofty share price, have a look at the Rydex S&P 500 Equal Weight Consumer Discretionary ETF (NYSE:RCD), which holds 80 stocks, including Ralph Lauren at a 1.24% weighting. Because it’s an equal-weighted fund, as opposed to a cap-weighted one, RL gets an equal weighting with the other 79 stocks in RCD’s portfolio. In the cap-weighted Consumer Discretionary Select Sector SPDR (NYSE:XLY), Ralph Lauren’s weighting is 0.73%. More important, in my experience, is that any time an equal-weighted index goes up against a cap-weighted index in the same sector, the equal-weighted index achieves better performance. Not always, but often.

Technology was on Jeff Reeves’ mind on Jan. 31. Reeves provided readers with five possible tech alternatives to Apple (NASDAQ:AAPL), the darling of the sector. His third pick was Red Hat (NYSE:RHT), which is known for its Linux open-source software. Many investors believe technology stocks are a must for a diversified portfolio. I don’t know if that’s true, but if you do want technology representation and Red Hat at the same time, the fund I’d look at is the Rydex S&P 500 Pure Growth ETF (NYSE:RPG), which has 1.01% of its net assets invested in the software developer as well as 20% in technology stocks in general. The average market cap of the 130 stocks in the fund is $17.9 billion, providing investors with good tech exposure in established companies. With annual turnover of just 21%, the fund will completely change just once every five years. While the expense ratio is a reasonable 0.35%, it’s important to note that the bid/ask spread on this fund is 5.14%, meaning a market order is best avoided. Coincidentally, the second-largest holding in the fund is Apple, at 1.45%.

On Feb. 1, Lawrence Meyers pointed out that Stanley Black & Decker (NYSE:SWK), the power-tools giant, is experiencing strong growth, yet its stock is a bargain. With earnings expected to grow 18% annually over the next five years, SWK’s PEG ratio of 0.65 makes it a serious value play. I’ve always liked both Stanley Tools and Black & Decker, and my fondness hasn’t faltered since the companies merged in 2010.

Here the recommended play is the Focus Morningstar Mid Cap Index ETF (NYSE:FMM). Its annual expense ratio is 0.12%, which is very reasonable. While Stanley Black & Decker is a top 10 holding in this ETF, its weighting is just 0.42% because fund holds 567 stocks. That’s O.K. Mid-cap stocks, in my experience, tend to produce long-term returns that are better than both large caps and small caps. The fund will give some unexpected pop to your portfolio, not to mention additional market-cap diversification.

On Feb. 2, Tom Taulli recommended McDonald’s (NYSE:MCD), suggesting that its growth in China makes the fast-food giant a better investment than Facebook. Since it also pays a dividend yield near 3%, it’s hard to argue with his logic. The tougher question is determining the ETF alternative that makes the most sense. By the time I’m finished, I want a kick-ass portfolio that lets you sleep at night while still performing well. So I’d avoid restaurant-specific ETFs, preferring something a little broader. The PowerShares Dynamic Food & Beverage Portfolio (NYSE:PBJ), while a little more expensive than some of the bigger ETFs, provides investors with a 30-stock portfolio that is spread across all market caps, including 33% in small-cap companies. McDonald’s is the No. 3 holding, with a 4.97% weighting, behind only Kroger (NYSE:KR) and Hershey (NYSE:HSY). With 87% of its assets invested in consumer-staples stocks, it’s a good defensive position.

On Feb. 3, Gene Marcial wrote about three dividend stocks with big dividend growth potential. Of the three, National-Oilwell Varco (NYSE:NOV) is the stock I find most interesting. NOV is a leader in oilfield services and will continue to generate tremendous free cash flow that ultimately will end up in the hands of shareholders.

In the case of National-Oilwell Varco, the fund that best meets our criteria — it owns a good chunk of the stock but also casts a wider net and isn’t expensive — is the Energy Select Sector SPDR Fund (NYSE:XLE), which invests 21% of its net assets in oilfield-service companies such as NOV and 79% in Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and other oil-and-gas producers. At 2.81%, National-Oilwell Varco is the eighth-largest holding of the portfolio, and the expense ratio is 0.18%. So for less than one-fifth of a percent, you’ve got the basic materials sector covered.

The bottom line: If you purchased National-Oilwell Varco, McDonald’s, Stanley Black & Decker, Red Hat and Ralph Lauren stock at the end of 2011, your year-to-date return would be 12.2%, compared to 7.2% for the five ETF alternatives discussed. While you might have better short-term returns with the stocks, you definitely would not have diversification — and that could come back to haunt you.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

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