This Vanguard ETF just hit an all-time high as it continues to outperform the S&P 500 and Nasdaq Composite over the past 3 years.

Over the past three years, the S&P500 produced a total return (capital gains and dividends) of 32.4%, exceeding the Nasdaq CompositeThe total return of 26.8%. Nevertheless, both indexes performed well during this period, especially since 2022 was the worst stock market calendar year since 2008.

Despite a widespread sell-off in growth stocks in 2022, Vanguard’s technology sector exchange traded fund (ETF) has produced a total return of just over 50% over the past three years and 187.6% over the past five years. THE Vanguard Information Technology ETF (NYSEMKT:VGT) includes top stocks like Microsoft, AppleAnd Nvidia. And with an expense ratio of just 0.10%, or $10 in annual fees for every $10,000 invested, it’s an extremely inexpensive way to invest in the sector.

Here’s a breakdown of the fund and why it might be worth buying now.

Image source: Getty Images.

Looking under the hood of the technology sector

Tech stocks and growth stocks are two terms that can be used seemingly interchangeably. But technology sector industries have major differences. The three broad categories are semiconductors, software, and hardware.

Nvidia is a fabless chipmaker that designs its products and outsources manufacturing to a company like Taiwan Semiconductor. There are also material and equipment suppliers like ASMLwhich makes products needed for mass production of chips, such as its extreme ultraviolet (EUV) lithography systems.

Software companies are generally categorized as infrastructure software – like Microsoft, Oracle, Adobe, Palo Alto NetworksAnd Crowd strike — or application software — such as Selling power, SAP, Intuition, ServiceNow, UberAnd Shopify.

Apple is unique because it is vertically integrated and makes its own software and hardware. But there are also hardware companies like Dell Technologies, Arista NetworksAnd HP.

Here’s an overview of how Vanguard defines each sector, the Vanguard Information Technology ETF’s weighting by sector, and an example investment for each category.

Industry

Weighting

Example of detention

Data source: Vanguard.

The story continues

One of the big advantages of a technology sector ETF is that it covers both hot, high-margin growth stocks as well as companies that are more industrial and manufacturing in nature. The spotlight is often on high-growth software stocks, but we rarely hear about the integral companies that are the picks and shovels of the industry.

An example is Amphenol, an $82 billion company that makes sensors, antennas, cables, fiber optic interconnects and more. The electrical components company is a staple of the technology sector and a stock you’ll find in the Vanguard Information Technology ETF that might otherwise be overlooked.

The sector is benefiting from increased adoption of technologies and innovations. But it all falls apart without a network of suppliers, manufacturing services and component companies.

The pros outweigh the cons

By far the biggest disadvantages of investing directly in the technology sector as opposed to a broader sector, more diversified growth fund are that it is the most expensive sector with a price-to-earnings (P/E) ratio of just over 40, and that it excludes many technology-oriented companies like Amazon, Alphabeticalt, and Metaplatforms which are classified in other sectors.

The sector’s valuation is high relative to the overall market, but it’s not great considering the sector’s growth potential. For context, the Invesco QQQwhich tracks the performance of the 100 largest non-financial companies in the Nasdaq Composite, has a P/E of 37.3.

Tech stocks are expensive right now due to the massive rise in stock prices and their huge growth potential. We can expect semiconductor and software companies to have generally higher growth rates and higher valuations than hardware and component companies.

The good news is that many companies are growing rapidly and are expected to continue to grow at a breakneck pace. You can learn a lot about investor expectations based on forward P/E ratios, which divide a stock’s price by its forward earnings projections for the following year instead of its trailing 12-month earnings.

MSFT PE Ratio Chart (Forward)

As you can see from the chart, even the hottest tech stocks have somewhat reasonable forward P/E ratios. Of course, these are only estimates and should be approached with caution, as forecasts rarely turn out as expected. But overall, the forward P/E estimates for many tech stocks make perfect sense and indicate why the sector isn’t as overvalued as it might first appear.

If you don’t care too much about passive income and have a high risk tolerance, you might prefer to buy Apple, Adobe, or Salesforce at forward P/E ratios below 29 rather than Walmart with its forward P/E of 27 or Procter & Gamble with a forward P/E of 25.3. Tech isn’t the only sector hitting an all-time high. The market is generally more expensive than in previous years, meaning investors have to pay for quality one way or another.

Growth is a beautiful thing

The Vanguard Information Technology ETF is the best ETF in the technology sector due to its low cost, large net assets, and Vanguard’s strong reputation. The fund is a particularly good choice for investors who want to gain more exposure to the entire sector rather than just selecting a handful of flagship stocks.

The valuation appears high, but if earnings forecasts are accurate, one could argue that it is fair, or even cheap.

The bottom line is that earnings growth is the main catalyst for a sustainable recovery and can justify even the highest increases. Nvidia is a good example as its earnings growth continues to fuel its stock price rise. The fact that the stock is up 582% over the last three years, but its P/E is still below 40, says a lot about the quality of its earnings growth.

Overall, technology remains a great long-term buy if you can stomach the cyclicality of the sector and approach investing with a time horizon of at least three to five years.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, former director of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Daniel Foelber holds positions in Advanced Micro Devices. The Motley Fool holds positions and recommends ASML, Accenture Plc, Adobe, Advanced Micro Devices, Alphabet, Amazon, Apple, Arista Networks, Cisco Systems, CrowdStrike, Garmin, Intuit, Meta Platforms, Microsoft, Nvidia, Oracle, Salesforce, ServiceNow, Shopify, Taiwan Semiconductor Manufacturing, Uber Technologies and Walmart. The Motley Fool recommends Broadcom and Helmerich & Payne and recommends the following options: long January 2025 $290 calls on Accenture Plc, long January 2026 $395 calls on Microsoft, short January 2025 $310 calls on Accenture Plc and $405 short calls in January 2026 on Microsoft. The Motley Fool has a disclosure policy.

This Vanguard ETF just hit an all-time high as it continues to outperform the S&P 500 and Nasdaq Composite over the past 3 years. was originally published by The Motley Fool

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