This Vanguard ETF Could Be the Best for Growth Stock Investors

As an investor, you can use exchange-traded funds in a variety of ways. Many investors choose to get coverage of the entire stock market in a single fund by focusing on ETFs that track broad-based indexes like the S&P 500 or Nasdaq 100. However, some investors want to beat the market, and by selecting an ETF that's a bit more selective about its own stock picks, they hope to do just that without a whole lot of effort.

One favorite strategy that has worked extremely well for a long time is growth stock investing. By concentrating on companies that are growing the fastest, you can sometimes get in on promising stocks before or during their most impressive moves higher. In looking at ETFs for the Voyager Portfolio, it makes sense to pick the Vanguard Growth ETF (NYSEMKT: VUG) to take a closer look at and figure out how it has managed to perform so well for so long.

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The kind of growth that Vanguard Growth looks for

The tricky thing about ETF investing is that your definition of a popular investing term might differ from the definition a particular fund uses. Vanguard Growth ETF tracks the CRSP US Large Cap Growth index, which includes over 150 stocks with market capitalizations ranging from around $5 billion to $4.5 trillion.

The Center for Research in Securities Prices, which was acquired by Morningstar (NASDAQ: MORN) earlier this year, uses growth and value factors to evaluate stocks. On the growth side, CRSP looks at short-term and long-term expected future growth in earnings per share, as well as historical growth in per-share earnings. It also considers sales growth on a per-share basis. Finally, CRSP examines the company's ratio of investment to assets and its return on assets.

With these criteria, CRSP generates a growth score. The index provider also generates a value score, based on ratios of the stock's price compared to book value, historical and future earnings, dividends, and revenue. By using some statistical analytical methods that rank and compare the two scores, CRSP is able to assign each stock to either the value stock or the growth stock category.

Once a stock is assigned to a category, it tends to stay there. However, there are mechanisms in place that allow stocks to migrate from growth to value or vice versa as scores change over time. What's necessary, though, is that a score move considerably toward the opposite style before CRSP starts to make the needed shift in its index holdings. When that happens, CRSP follows a two-step process, moving half of assets to the other style immediately but then waiting for confirmation in the following quarter before proceeding with the rest of the move.

Surprise! Tech dominates Vanguard Growth

The net result of CRSP's calculations is that the Vanguard Growth ETF's portfolio is heavily weighted toward the technology sector. Over 50% of the fund is invested in stocks that officially get classified as tech stocks. However, when you add in stocks that are technically part of the consumer discretionary or communication services sectors but that most investors consider to be tech stocks, that proportion rises to more than two-thirds of the fund's assets. By contrast, energy, materials, real estate, and consumer staples together add up to just 4% of the fund's investments.

In addition, the fact that Vanguard Growth is market-cap weighted means that it's top-heavy. The top six holdings get half of the total investment capital of the fund. Nvidia (NASDAQ: NVDA) alone accounts for 12% of assets.

Growing for investors

Growth investors have one goal: growing the size of their portfolio. On that score, the Vanguard Growth ETF has done a great job. In the second article of this three-part series on Vanguard Growth ETF for the Voyager Portfolio, you'll see just how well the fund has done and why it has become such a popular choice among investors.

Dan Caplinger has positions in Nvidia. The Motley Fool has positions in and recommends Nvidia and Vanguard Growth ETF. The Motley Fool has a disclosure policy.