Investment management company Vanguard offers a variety of sector-based Exchange Traded Funds (ETFs) that reflect the performance of all 11 Global Industry Classification Standard stock market sectors. The Vanguard Information Technology ETF (NYSEMKT: VGT) has an expense ratio of just 0.1% and a minimum investment of just $1, making it an easy way to dip your toes into the tech sector at a low cost.
The semiconductor industry is the main driver behind the technology sector’s continued rally. But software giant Salesforce (NYSE: CRM) just rose to a new record level. And Adobe (NASDAQ: ADBE) is up more than 15% from its 52-week low since May.
Let’s see if a boom in software stocks can help take the Vanguard Tech ETF to new heights and identify some risks worth considering before investing in top software stocks.
Image source: Getty Images.
How enterprise software invests in AI
Talking about the technology sector without mentioning artificial intelligence (AI) is impossible. After all, Nvidia (NASDAQ: NVDA) has become the most valuable company in the world due to the enormous growth potential of AI. More computing power is needed to power AI models, and Nvidia is leading the way in creating graphics processing units and associated hardware for data centers.
But to make the AI story sustainable, companies must develop and benefit from AI tools. The pressure is on companies that use business software Microsoft (NASDAQ: MSFT)Salesforce and Adobe to prove AI spend is worth it.
Microsoft’s research and development spending has soared as it invests in AI solutions. AI assistants called Copilots are embedded in various applications, such as Microsoft 365, GitHub, Azure and more. On October 21, Microsoft unveiled new autonomous agents for business processes such as sales, finance and supply chains.
Salesforce has touted the benefits of its Agentforce suite of AI agents. Agentforce could become a lucrative value add to Salesforce’s leading customer relationship management platform and Salesforce-owned Tableau and Slack.
Adobe has developed many AI tools, such as the generative AI text-to-image tool Firefly and an AI assistant for Adobe Acrobat that can provide summaries of PDFs.
Despite their potential, AI developments have not yet led to blistering growth for Salesforce and Adobe. Adobe’s margins have stalled and Salesforce has only recently started generating consistent revenue. Neither company has grown revenue impressively in recent years. Salesforce’s revenue over the last 12 months is up just 37.7% in three years, while Adobe’s is up just 32.7%.
Enterprise software companies that rely on software-as-a-service (SaaS) business models must balance innovation without shrinking their customer base. For example, the Adobe Creative Cloud All Apps Business plan costs $89.99 per month per license. Suppose Adobe improves its suite of apps so much that it can charge $135 per month per license. But because each user can accomplish so much more, an Adobe business customer decides he only needs 10 licenses instead of 20. Adobe would ultimately achieve higher revenue per license, but lower overall revenue. In other words, the innovation would lead to a crack in the business model.
The biggest question facing enterprise software companies is how they will modernize the SaaS business model in the AI era so that they are not so dependent on the number of licenses. The uncertainty that software companies face is one reason why semiconductor companies are leading the technology sector, not the software sector. Software companies face the challenge of monetizing AI without compromising their existing business models, while a company like Nvidia benefits from the overall adoption of AI. So Nvidia is a safer and easier way to bet on AI than a specific enterprise software company.
Breaking down the Vanguard Tech ETF
Even if Salesforce and Adobe continue to move higher, they might not have a meaningful impact on the Vanguard Tech ETF. As you can see in the following table, a whopping 44.6% of the Vanguard Tech ETF is invested in AppleNvidia and Microsoft – illustrating the sheer size of these giants compared to other tech companies.
|
Company |
Weight in the Vanguard Information Technology ETF |
|---|---|
|
Apple |
15.8% |
|
Nvidia |
15.4% |
|
Microsoft |
13.4% |
|
Broadcom |
4.6% |
|
Salesforce |
1.8% |
|
Oracle |
1.8% |
|
Advanced micro devices |
1.5% |
|
Cisco systems |
1.5% |
|
Adobe |
1.4% |
|
Accenture |
1.4% |
Data source: Vanguard.
It’s also worth understanding how the ETF is allocated by sector. As you can see in the following table, about a third of the ETF is now in semiconductor companies. The semiconductor industry’s influence on the technology sector extends far beyond Nvidia.
|
Category |
Weight in the Vanguard Information Technology ETF |
|---|---|
|
Application and system software |
35.2% |
|
Semiconductors and semiconductor materials and equipment |
33.1% |
|
Technology hardware, storage, distributors and peripherals |
18.3% |
|
Electronic components, equipment, instruments and manufacturing services |
4.4% |
|
IT advice and other services |
3.7% |
|
Communications equipment |
3.6% |
|
Internet services and infrastructure |
1.7% |
Data source: Vanguard.
For example, diversified semiconductor, hardware and networking company Broadcom alone makes up a larger portion of the ETF than Salesforce and Adobe combined.
A better way to target software stocks
The Vanguard tech ETF is a great way to gain broad exposure to the technology sector, but it is not the best way to invest in application and infrastructure software companies. Investors interested in top enterprise software companies such as Oracle, Salesforce, Adobe, ServiceNowAnd Intuitive might prefer to just buy shares of those individual names or software ETFs like the iShares Comprehensive Tech-Software Sector ETF (NYSEMKT: IGV).
By focusing solely on software companies and ignoring chip stocks and major hardware companies like Apple, investors get much more exposure to enterprise software names. For example, the ETF has a 9.4% weighting in Salesforce, which is more than five times higher than the Vanguard Tech ETF.
In short, Apple, Nvidia and Microsoft have become so big that they will continue to drive the Vanguard Tech ETF. Investors who already own these three companies and don’t want further exposure may want to consider investing in other technology stocks or ETFs instead.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Accenture Plc, Adobe, Advanced Micro Devices, Apple, Cisco Systems, Intuit, Microsoft, Nvidia, Oracle, Salesforce and ServiceNow. The Motley Fool recommends Broadcom and recommends the following options: long January 2025 calls of $290 on Accenture Plc, long January 2026 calls of $395 on Microsoft, short January 2025 calls of $310 on Accenture Plc, and short calls in January 2026 of $405 on Microsoft. The Motley Fool has a disclosure policy.
