Economy

A tech-heavy portfolio can be still considered diversified. Here’s how

Aniket Pujari December 24, 2023

Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week’s question: Can you discuss how to weigh sectors to be diversified without technology dominating? My portfolio includes AAPL and MSFT. By adding cybersecurity, PANW, and semiconductors, AVGO, can these be counted as different sectors than technology as their importance grows? And, in a portfolio of 10-15 stocks, how many of Magnificent Seven can be added while being diversified? – Thank you, Cathryn, San Francisco We certainly understand and agree it’s becoming increasingly difficult to maintain a diversified portfolio that’s not dominated by technology stocks. Perhaps, the issue is that we need to think about tech differently, not simply based on the way the S & P 500 index’s sectors break down. The current 11 sectors of the S & P 500 puts Information Technology at No. 1 with a 29.1% weighting . The six Club stocks in the sector are Nvidia , Apple, Broadcom , Microsoft, Palo Alto Networks , and Salesforce . There are also what many investors would think of as tech companies in S & P 500 Communication Services , at an 8.6% weighting. It was created in a 2018 reshuffling to reflect an evolving tech and consumer landscape. For us, the stocks in the sector are Alphabet and Meta Platforms . Amazon , which also screams tech, is in Consumer Discretionary , a sector that accounts for 10.7% of the S & P 500. Following the S & P 500 sector weightings might help in the short term if/when the market indiscriminately rotates out of one sector in favor of another. But we don’t think that’s the best way to approach the market over the long term — trying to nail the rotation game consistently over many years. Keep in mind, that sector designations can change. Before 2018, Meta and Alphabet were once designated as technology stocks. But if you owned them then, you didn’t suddenly become more diversified when the classifications changed overnight. It’s better to focus on fundamentals – regardless of sector – given that on a longer time horizon stocks tend to follow fundamentals. After all, we would say Meta, Alphabet and Amazon are as much tech companies as Apple or Microsoft, with all three considered leaders in artificial intelligence. While Amazon may generate more sales from e-commerce, the profits and growth come from its AWS cloud division. We’ve also argued that in some respects, in terms of the stock’s valuation, Apple should be thought of as a consumer products company rather than simply a technology company – despite it having best-in-class technology in both hardware and software. In this day and age, every company needs to be a technology company in some way. They don’t necessarily need to sell tech products and/or services but if they aren’t figuring out how to leverage technology to increase efficiencies, then they will be disrupted. That’s one reason we like and own Honeywell and Eaton . Both are technically in the S & P 500 Industrials sector. However, we are invested in them because of their technological prowess, be it digitization, electrification, or the ability to help customers automate. These are industrial technology companies, not the industrial companies of old. If you start to think about the companies more in terms of end markets and cyclicality, and the correlations to one another, and less so in terms of a sector designation, we think it’s easier to think about diversification without concerning yourself too much with the sector weightings of your portfolio. Different end markets mean different business cycles. For example, while there are some concerns about consumer spending power in 2024, there is also an expectation that enterprise IT budgets are set to rebound and with them cloud growth rates. At the same time, AI semiconductor stocks have been red hot for a while now. However, the more traditional legacy semiconductor names have been under pressure and are only now expected to start coming off the bottom of the cycle. So, using some of the examples provided in the question: Yes, Microsoft and Apple are both considered Information Technology companies. However, Microsoft is more leveraged to the enterprise and cloud computing dynamics, thanks to Azure, which is the primary driver of the stock. On the other hand, Apple’s bread and butter is the consumer as the bulk of sales and earnings are tied to iPhone sales and the associated services that can be sold to those users. Or, consider Meta and Alphabet, both are AI leaders and generate the bulk of sales from advertising. The tech they implement to target ads is best-in-class, but they aren’t considered technology. At the same time, they’re not considered Consumer Discretionary companies either, even if their revenue fluctuates based on ad buyer appetites that result from consumer buying power. While a Consumer Discretionary company, Amazon, is so much more than just e-commerce and cloud. It’s into online advertising and video streaming as well. Amazon’s e-commerce has certainly proven a swing factor for the stock and earnings, with management working to revamp its cost structure and increase logistics efficiency. The bulk of growth comes from its Amazon Web Services (AWS) cloud division. Over the past year, the stock has traded much more closely with Microsoft than other top-weighted names in Consumer Discretionary – aside from Tesla, which has been grouped in as a Magnificent Seven stock and tends to have a trading profile all its own. After reporting earnings, Amazon shares sold off on the print only to about-face when management highlighted strong cloud deals coming through shortly after the reported period ended. So, it was prospects in the cloud, not e-commerce that investors were latching on to. As for the Magnificent Seven part of the question, we think the group is pretty diverse except for Meta and Alphabet, which both rely heavily on advertising spending and their ability to target those ads. As a result, we think a 10 to 15 stock portfolio can still prove diverse even with the majority of the Magnificent Seven present, though it may be a good idea to consider the weighting of each stock in the context of how it relates to the others. In other words, if you want to own both Meta and Alphabet, consider the combined weighting of those names, realizing that they are going to be more correlated as both will move based on advertising dynamics. But even here, there are different factors to consider, for example, Meta’s active user metrics matter — and with Alphabet, it’s about Google Search market share and its ability to compete with Microsoft in generative AI. Bottom line We do think you would be right to think about companies and stocks beyond simply their sector classification as that alone will not ensure diversification. Instead, we reiterate, think more about customers, end markets, business cycles, geopolitical influences, outcomes, regulations, valuations, pretty much everything other than stale sector designations. That’s a big reason as to why, though we preach the importance of a diversified portfolio, we tend not to overly concern ourselves with the technical sector weighting of our portfolio. At best, it offers a little value and at worst we think it could be misleading by indicating to members that sector weighting is how you determine diversification. (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

This week’s question: Can you discuss how to weigh sectors to be diversified without technology dominating? My portfolio includes AAPL and MSFT. By adding cybersecurity, PANW, and semiconductors, AVGO, can these be counted as different sectors than technology as their importance grows? And, in a portfolio of 10-15 stocks, how many of Magnificent Seven can be added while being diversified? – Thank you, Cathryn, San Francisco

Aniket Pujari

6,159 Posts

Aniket Pujari is a passionate finance and technology enthusiast with a strong academic background in Financial Markets. Since 2015, he has been deeply immersed in the world of cryptocurrencies, blockchain technology, and global financial systems, building a wealth of knowledge and expertise in these rapidly evolving fields.

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A tech-heavy portfolio can be still considered diversified. Here’s how

Aniket Pujari

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