Tech Looks Good
Nine of the 33 recommended stocks on the Buy List or Long-Term Buy List are technology companies — the most of any sector. Our fondness for tech is no accident.
Compared to other sectors, technology companies offer a particularly compelling combination of improved Quadrix® scores, strong profit-growth prospects, and attractive valuations. Consider the following:
• Solid average Quadrix scores. The average S&P 1500 technology stock earns an Overall score of 62 — the highest level since August 2008 and up from 51 at the start of the year. The sector’s 10-year average Overall score is also 51.
• Lots of Quadrix standouts. With 718 stocks, technology has the second-largest representation in our research universe of more than 4,000 stocks, trailing only financials (863). Nearly one-quarter of technology companies earn Overall scores above 80. Importantly, of the 409 stocks with Overall scores above 90, 97 are technology firms — tops among the 10 sectors.
• Reasonable valuations. At 23 times trailing earnings, the average tech stock trades at a discount to its five-year average P/E ratio of 25. Based on estimated current-year earnings, tech stocks have rarely been cheaper. The P/E ratio based on estimated year-ahead earnings is 16, well below the five-year average of 22. The Value score of 53 is the highest since late 2008.
• Strong earnings momentum. Despite a somewhat tenuous backdrop for technology spending, the average tech company in the S&P 1500 is expected to deliver 30% per-share-profit growth this year and 22% next year. Nearly 80% of tech firms are expected to post higher earnings this year, while 93% are forecast to grow in 2011.
For new buying, two especially attractive technology names include Microsoft ($23; MSFT), reviewed in Analysts' Choice, and IBM ($123; IBM). IBM seems unduly cheap given its growth outlook and substantial free cash flow. The consensus projects per-share profit growth of 13% this year and 10% in 2011, and estimates are rising. Over the next five years, per-share earnings are expected to increase at an 11% annualized clip. At the end of June, trailing 12-month free cash flow from operations was $2.11 billion, or nearly $10 per share.
The Quadrix Value score of 69 is much better than the industry-group average of 51. Based on trailing earnings and the five-year average P/E of 14.5, the stock’s implied price target is around $150, up 22%. Based on peer-group average P/Es, the stock seems worth $160. In our view, the shares seem capable of reaching $145 over the next 12 months. IBM is a Focus List Buy and a Long-Term Buy.