Tech Looks Timely

12/5/2016


Stocks in the S&P 1500 Technology Sector Index have risen an average of 18% in 2016, ahead of the broad index's 16% gain. The rally has pushed tech stocks' average Quadrix Value score down to 49, versus the index average of 55, as shown below. But tech stocks look especially attractive based on timely indicators, such as operating momentum, earnings-estimate revisions, and share-price action.

The overall sector's strong performance has obscured recent weakness for bellwethers. Shares of some of the largest technology companies — Alphabet ($776; GOOGL), Amazon.com ($751; AMZN), Apple ($111; AAPL), Cisco Systems ($30; CSCO), Facebook ($119; FB), Hewlett-Packard Enterprise ($24; HPE), and Microsoft ($60; MSFT) — have struggled in the weeks since the election on Nov. 8.

In some instances, recent weakness may simply be the result of investors selling off their winners and rotating into sectors such as industrials and financials. However, Donald Trump's immigration policies could cast more scrutiny on the visas used by many companies to employ foreign workers. Tariffs or other disruptions in global trade could hurt companies that conduct a large percentage of their business overseas. At the same time, Trump has hinted about a tax holiday that would let companies repatriate overseas cash, potentially boosting dividends and stock buybacks.

As we've seen with the Brexit and U.S. presidential election this year, trying to handicap how political events play out is often a fool's errand. We prefer to focus on the underlying operating strength and valuation of individual stocks. Below, we review three of our favorite picks in the technology sector:

Alphabet ($776; GOOGL) shares have slipped 4% since the U.S. presidential election on Nov. 8, missing out on the 3% advance by the S&P 500 Index. Yet analyst-revision trends remain upbeat, with the consensus profit estimate for 2017 rising to $40.89 per share, implying 19% growth.

President-elect Trump has suggested he may take an antitrust stance against large technology companies, and his trade policies may also hurt their ability to expand in foreign markets. But Trump's possible tax holiday could be a big positive for Alphabet, which ended the September quarter with 60% of its $83.1 billion in cash overseas. Alphabet is a Focus List Buy and a Long-Term Buy.


CDW's ($51; CDW) per-share profits rose 17% in the first nine months of 2016, while revenue grew 10%, cash from operations 69%, and free cash flow 87%. The company announced a 49% hike to its quarterly dividend in November, as it seeks to reach a payout rate of 30% of free cash flow by 2019; CDW's current payout ratio is roughly 16%.

The shares have rallied 15% since the presidential election and are now up 22% for 2016. Despite that rally, the stock trades at 16 times trailing earnings, a 20% discount to its three-year average and 25% below the median S&P 1500 technology stock. Encouragingly, analyst profit estimates for 2017 have risen in the past 30 days, with the current consensus projecting 8% profit growth. CDW is a Focus List Buy and a Long-Term Buy.


VMware ($81; VMW) develops data-center products that help clients improve efficiency. Smaller companies are steering their data-center needs toward cheaper alternatives offered by cloud vendors such as Amazon Web Services. But larger companies seem less likely to follow suit.

More than 50% of VMware's revenue comes from software maintenance, contributing to steady growth — sales have risen at least 5% in 28 consecutive quarters. Free cash flow jumped 54% to $2.24 billion for the 12 months ended September. The balance sheet brims with net cash of $6.75 billion, or nearly $16 per share, up 18% from a year ago. The stock earns an Overall score of 98, and both sector-specific ranks exceed 98. VMware is a Buy and a Long-Term Buy.

8 TOP TECH STOCKS
12-Month
--- Change ---
Est. EPS
Change,
Next 12
Months
(%)
Trailing
P/E
Ratio
P/E
Based
On Est.
EPS
YTD
Total
Return
(%)
---------------- Quadrix Scores -----------------
Company (Price; Ticker)
EPS
(%)
Sales
(%)
Momen-
tum
Earns.
Ests.
Overall
12-
Factor
Sector
Reranked
Overall
Industry
Alphabet
($776; GOOGL)
29
19
17
23
20
0
93
78
87
83
85
Internet
software
Apple ($111; AAPL)
(11)
(8)
9
13
12
7
37
46
85
55
83
Tech
hardware
Applied Materials
($32; AMAT)
34
12
39
18
13
75
98
90
97
61
98
Semiconductor
equip.
CDW ($51; CDW)
23
10
8
16
14
23
59
72
88
32
92
Tech
distributors
Citrix Systems
($87; CTXS)
73
6
(1)
16
16
15
88
80
93
97
92
Application
software
F5 Networks
($141; FFIV)
9
4
13
19
17
45
81
92
96
93
97
Telecom
equipment
Lam Research
($106; LRCX)
9
4
31
17
13
35
81
84
96
87
97
Semiconductor
equip.
VMware ($81; VMW)
8
7
10
19
18
43
87
94
98
100
99
Systems
software
S&P 1500
tech average
2
7
10
23
22
18
56
56
58
50
49
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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