Is Vanguard Value Index the Right ETF for Today's Market Environment?

Key Points

• The S&P 500 index is near all-time highs and has an average P/E of around 27.6.

• Some worry that the market's focus on growth stocks has pushed valuations too far.

• Vanguard Value Index ETF could be the perfect option for more cautious investors.

• 10 stocks we like better than Vanguard Index Funds - Vanguard Value ETF ›

Vanguard S&P 500 ETF (NYSEMKT: VOO) has an average price-to-earnings ratio of 27.6 and a price that is near all-time highs. This market tracking index exchange traded fund (ETF) highlights the risk in the market today as valuations get stretched by enthusiastic investors. If the market environment has you worried, the right ETF for you could be Vanguard Value ETF (NYSEMKT: VTV). Here's why.

What does Vanguard Value ETF do?

Vanguard Value ETF is an index-tracking ETF, so, technically, it doesn't do anything but buy the same stocks as the index it is tracking. The index it tracks is the CRSP US Large Cap Value Index. You probably haven't heard of that index, as it was created specifically so an exchange traded fund could track it.

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Without getting too deep in the woods, the index determines value by looking at metrics like book-to-price ratio, future earnings-to-price ratio, historical earnings-to-price ratio, dividend-to-price ratio, and sales-to-price ratio. These are all slightly different ways of looking at more traditional valuation metrics, like price-to-sales and price-to-earnings. A composite score is created from these measures and large companies that fall into the "value" category end up in the index's portfolio using a market cap weighting.

There's actually a lot of math going on under the hood here, but the big picture is that Vanguard Value ETF buys exactly what you would expect it to, just with a large company focus. And that might be exactly the type of investment you want today given the lofty valuation levels of the broader market.

Some ETF comparisons will help

The S&P 500 index, which the Vanguard S&P 500 ETF tracks, has an average P/E ratio of 27.6 today. The average price-to-book value ratio is 5. Driving those numbers higher have been a small number of large growth stocks, notably including many technology companies. To highlight this fact, the P/E ratio of Vanguard Growth ETF (NYSEMKT: VUG) is an even higher 39.4, with a P/B ratio of 12.1.

For many investors it will feel like they are sitting in the market's nose-bleed seats right now. But you don't have to lean into growth like the rest of the market. You can simply layer in some value using an ETF like Vanguard Value ETF. This ETF's average P/E ratio is a far more reasonable 19.6, with an average P/B ratio of 2.8.

To be fair, a nearly 20 P/E isn't exactly cheap on an absolute basis, but in today's market it is a much cheaper valuation than other alternatives. If your portfolio is tilted too far in the growth direction, which it could be even if you just own an S&P 500 tracking ETF, Vanguard Value ETF could help bring back some value sanity to your portfolio. And, perhaps, ease your nerves at a time when the market is hitting all-time highs.

Vanguard Value ETF is low cost insurance

The market tends to swing between focusing on growth stocks and focusing on value stocks. Right now, growth is in favor, which is a sign that it might be time to shift, at least a little bit, toward a value bias. Vanguard Value ETF allows you to do that with one simple investment. And the best part is that the expense ratio is a very small 0.04%. This could be cheap insurance if today's market environment has you worried that the valuation of growth stocks are getting stretched.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Growth ETF, Vanguard Index Funds-Vanguard Value ETF, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.