"I suggest Vanguard's."
Warren Buffett wrote those words in his 2013 letter to Berkshire Hathaway shareholders. The legendary investor had just explained why his will instructs that most of the cash his family inherits be invested in a low-cost S&P 500 index fund. Buffett didn't mind giving his preference of which one with his comment about Vanguard.
I think Buffett's choice of Vanguard is a good one. However, with the S&P 500 trading at a lofty valuation, other exchange-traded funds (ETFs) within the Vanguard family could be smarter picks for investors. One Vanguard ETF especially looks like a no-brainer buy right now.
Everything energy
The Vanguard Energy Index Fund ETF(NYSEMKT: VDE) attempts to track the performance of the MSCI U.S. IMI Energy 25/50 Index. The "IMI" in the fund's name stands for "investable market index." The "25/50" refers to the index's requirements that no more than 25% of assets be invested in a single issuer, and that the sum of the weights of all issuers representing over 5% of the ETF can't exceed 50% of total assets.
The most important thing to know about VDE is that it focuses on everything energy-related. This ETF owns 113 stocks of companies involved in all aspects of the energy sector.
VDE's top holdings include oil and gas giants ExxonMobil, Chevron, ConocoPhillips, EOG Resources, and Marathon Petroleum. However, the ETF also owns significant stakes in other energy stocks, such as oilfield services leader Schlumberger and natural gas infrastructure company Williams Companies.
Vanguard is known for offering low-cost funds. VDE is a good example. The ETF's annual expense ratio is only 0.10%, much lower than the 0.99% average of similar funds.
Why VDE looks like a no-brainer pick
As I mentioned earlier, the S&P 500's valuation is high. The S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio (sometimes referred to as the Shiller CAPE ratio) is just a hair below 33 -- nearly twice its long-term average.
S&P 500 Shiller CAPE Ratio data by YCharts
However, VDE is cheap by comparison. Its price-to-earnings ratio is only 12.4. This attractive valuation isn't because of sluggish earnings growth, either. Stocks owned by the ETF have delivered average earnings growth of 31.3% over the last five years.
VDE also offers a 30-day SEC yield of 2.71%. This yield is nearly double that of the Vanguard S&P 500 ETF. Such a strong yield means that VDE doesn't have to generate all that much share price appreciation for investors to enjoy solid total returns.
But I suspect that VDE's share price will increase significantly over the next few years. Why? An oil supply shortage could be on the way. Occidental Petroleum CEO Vicki Hollub predicts an oil supply shortage by late 2025. She doesn't think crude oil reserves are being replaced quickly enough.
Other oil industry executives agree with Hollub about the market dynamics. If they're right, oil prices will likely rise in the second half of this decade. That's bullish for energy stocks -- and for VDE.
Use some brain power
Is the Vanguard Energy ETF really a no-brainer buy right now? Investors should always use some brain power before buying any stock or ETF. There are always risks to consider. In VDE's case, it's possible that the Chinese economy could struggle and reduce the demand for oil and gas. OPEC could also ramp up its production dramatically.
However, I think the outlook for VDE looks quite good. This Vanguard ETF provides an easy way to invest in a large basket of energy stocks that are valued attractively as a group and that should have strong growth prospects.
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Keith Speights has positions in Berkshire Hathaway, Chevron, ExxonMobil, Vanguard S&P 500 ETF, and Williams Companies. The Motley Fool has positions in and recommends Berkshire Hathaway, Chevron, EOG Resources, and Vanguard S&P 500 ETF. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.
