Taking Stock Of Tech
The technology sector, once our favorite fishing hole, is currently stocked with fewer keepers. The number of S&P 1500 Index technology stocks with Quadrix Overall scores above 80 or 90 remains well below levels from the prior couple years.
The Forecasts does not set target portfolio weightings for sectors, and our recommended lists tend to become overweighted relative to the market when we find a lot of attractive stocks in a particular sector. So it's not surprising that the composition of the Buy List reflects the technology sector's shortage of attractive candidates.
In recent quarters, traditional tech titans such as Hewlett-Packard ($28; HPQ), IBM ($185; IBM), Microsoft ($37; MSFT), and Oracle ($38; ORCL) have struggled to top consensus estimates in a consistent manner. Some have grown so big that acquisitions and new innovations barely move the needle. Others face threats from nimble start-ups that offer cloud-based software to businesses, undercutting the bulky, lucrative contracts that once assured the tech giants of steady growth.
Yet as a group, big tech stocks still look more attractive in Quadrix than their smaller peers. On average, tech stocks in the S&P 500 Index score substantially better than those in the S&P MidCap 400 and S&P SmallCap 600 for Overall, Value, Quality, and Financial Strength.
While technology no longer dominates our buy lists, we currently recommend nine tech stocks for purchase. Four are reviewed below, and Cognizant Technology Solutions ($99; CTSH) is profiled in Analysts' Choice.
Alliance Data Systems ($258; ADS) offers direct-marketing services, customer-loyalty programs, and private-label credit cards to help businesses reach audiences fracturing into smaller groups. The stock has gained 78% since the beginning of 2013, dragging down its Value (33) and Overall (69) scores. Alliance's trailing P/E ratio, currently 27, has steadily expanded over the past four years. The P/E is third-highest among our recommended stocks and 60% above the average of 17. However, Alliance has delivered double-digit sales growth in 14 of the past 16 quarters, with its Epsilon (loyalty programs and marketing databases) and private-label cards driving recent growth.
Such operating momentum warrants a premium valuation, and the growth shows little sign of slowing. The private-label unit (47% of sales and 66% of operating income in the first nine months of 2013) saw its average receivables balance rise 14% year-over-year in both October and November, boding well for December-quarter results. The consensus targets earnings per share of $11.50 for the 12 months ending September 2014, implying 21% growth — three times average projected growth for S&P 1500 data-processing and outsourcing stocks. Alliance Data Systems is a Focus List Buy and a Long-Term Buy.
EMC ($25; EMC) shares were roughly flat in 2013, lagging the average gain of 58% for computer storage and peripherals stocks in the S&P 1500. After sitting out the market's broad rally, the stock looks cheap from virtually every angle. It scores in the top half of our research universe for nearly all the factors that comprise our Value rank — and in the top one-fifth for nearly two-thirds of those factors.
EMC's growth prospects appear intact. The consensus expects EMC to increase per-share earnings 14% to $1.98 in the 12 months ending September, exceeding its industry's average growth of 10%. Shares trade at less than 13 times projected earnings for fiscal 2014. If EMC's trailing P/E ratio remains at its current depressed level of 14 and management meets the current consensus, shares will rally 14% over the next 10 months. Should the P/E climb to 18 — returning halfway to its three-year average of 22 — the shares could reach $36. EMC, earning a Value rank of 91, is a Long-Term Buy.
Qualcomm ($74; QCOM) Chief Operating Officer Steve Mollenkopf will become CEO of the company March 4, the first to take the helm outside of the company's founding family. Paul Jacobs, son of Qualcomm's co-founder, will serve as executive chairman. Mollenkopf inherits Qualcomm's formidable patent portfolio, a fortress that should protect the company's share of the market for high-end smartphones and tablets. Qualcomm enjoys a near monopoly for Long Term Evolution (LTE) semiconductors, technology key to many fourth-generation (4G) wireless networks.
Threats by Chinese officials regarding an antitrust probe could cause short-term headaches. But Qualcomm is poised to benefit from Apple's deal with China Mobile ($53; CHL) and the rollout of new cellular networks throughout the country.
The stock remains a Quadrix standout, with both sector-specific ranks topping 80, an Overall score of 97, and all category scores exceeding industry averages. Qualcomm has grown cash from operations by double-digit rates in nine of the past 11 quarters. Sales have risen at least 10% in 13 consecutive quarters, a trend expected to continue through at least the March quarter. At 16 times trailing earnings, the stock trades 25% below its five-year average and 24% below the sector median. Yielding 1.9%, Qualcomm is a Focus List Buy and a Long-Term Buy.
Visa's ($220; V) Overall rank is just 60, the result of sagging scores for Value (24) and Earnings Estimates (38). But its outstanding growth trajectory has continued in the past year, with both sales and per-share profits climbing 13% in the 12 months ended September. Cash from operations has risen in four of the past five quarters, while free cash flow totaled $4.83 billion in the first nine months of 2013. The balance sheet boasts $5.17 billion of cash without a speck of debt.
U.S. spending increased about 3.5% during this past holiday season, according to MasterCard Advisor's SpendingPulse report that tracks consumer spending on key retail categories. Shoppers are also becoming more comfortable making online purchases, increasing the usage of credit and debit cards.
The consensus projects Visa's per-share profits will climb 17% to $8.89 in the 12 months ending September, roughly matching the projected growth rate of its closest rival, MasterCard ($828; MA). But Visa shares look cheaper, trading at 29 times expected earnings, an 11% discount to MasterCard. Visa is a Buy and a Long-Term Buy.