Tech Sector Bursting With Potential
December-quarter results show that businesses are ratcheting up their technology spending, with broad strength across data storage and semiconductors, services, software, and even printer ink. And while the market for personal computers (PCs) remains a weak spot in consumer electronics, global smartphone shipments jumped 72% in 2010. In fact, smartphones outsold PCs in the December quarter, a first. The market for tablet computers is expected to triple this year.
In January, industry researcher Gartner ($37; IT) raised its 2011 growth projection for global tech spending to 5%, about the same pace as 2010.Â
Buoyed by strong operating momentum, the technology sector earns high marks in our QuadrixÂ® stock-rating system. Technology stocks in the S&P 1500 Index average an Overall score of 64 — higher than any other sector — and rank first, second, or third in five of the six category scores. About 37% of S&P 1500 technology stocks earn Overall scores above 80, and more than one in five scores above 90.
Our favorite picks in the tech sector — Altera ($41; ALTR), Apple ($360; AAPL), IBM ($163; IBM), and Texas Instruments ($36; TXN) — share some favorable qualities:
• December-quarter results: All four topped consensus estimates, producing double-digit growth in per-share profits. Revenue also exceeded expectations.
• Cash provided by operations (CPO): All four delivered year-to-year growth in CPO in the December quarter. Altera, Apple, and TI grew CPO more than 44% in the year ended December. IBM's full-year CPO slipped 6% from 2009 levels but still represented the second-highest in its history.
• Profit-estimate revisions: For all four, consensus estimates for earnings per share have advanced in the past 30 days, with gains for both the March quarter (up at least 3.1%) and current fiscal year (up at least 2.6%). All four earn Earnings Estimates ranks in the top 15% of our research universe.
• Quadrix scores: All four earn Overall scores of at least 94, with Value scores of 60 or higher.
Shares of Altera ($41; ALTR) hit a nine-year high in September and have notched new highs in each subsequent month, rising 66% since the end of August. But the stock's Quadrix Value score has merely dropped to 60 from 65, as the company's outstanding operating momentum kept up with the share gains. Altera aims to grow at twice the pace of the overall semiconductor market. It nearly did so last year, growing sales 63%, versus the average 33% gain for semiconductor companies in the S&P 1500 Index. Altera's 66% sales growth over the last six months nearly tripled its peer-group average.
Altera specializes in programmable semiconductors — microchips shipped blank and later programmed to fit the customers' needs — which tend to be cheaper than other types of chips, in part because they can be made in massive quantities. The company is seeing strong demand in end markets for telecommuni-
cation/wireless (44% of 2010 revenue) and networking/storage (14%). Revenue growth from industrial clients (22%) decelerated in the December quarter because of weak military demand. Altera trades for a reasonable 16 times trailing earnings, 22% below its five-year average and in line with semiconductor stocks in the S&P 1500 Index. Altera is a Focus List Buy and a Long-Term Buy.
Apple's ($360; AAPL) sales growth has accelerated in each of the last four quarters. Free cash flow, up at least 50% for five straight quarters, has lifted Apple's cash hoard to nearly $27 billion ($29 per share), with no debt. Operating profits per share jumped 74% in the past year, and return on equity climbed steadily.
Analysts keep underestimating the company's growth, with Apple beating the consensus profit estimate by at least 12% in each of the last four quarters. Apple owes much of its success to the iPhone, as shipments surged 87% in 2010. Wall Street sees per-share profits rising at a 21% annual clip over the next five years. Apple's PEG ratio (P/E on current-year estimated earnings divided by the long-term earnings growth rate) is 0.8, compared to an average of 1.2 for computer-hardware stocks in the S&P 1500. Apple is a Focus List Buy and a Long-Term Buy.
In the past four years, IBM ($163; IBM) has made 24 acquisitions in the analytics market, where data drawn from multiple industries helps companies plot business strategy. In advertising the merits of such a service, IBM could hold itself up as a success story. IBM's own internal analysis led to the decision to abandon the personal computer in 2005 in favor of higher-margin ventures in other markets.
That plan helped shape 2010 results, which exhibited broad strength across IBM's three principal units: services (revenue up 3%), software (up 5%), and hardware (up 11%). Revenue generated by the analytics operation, which straddles the services and software units, grew 19% in the December quarter, its biggest gain since the unit formed two years ago. Per-share profits rose 15% to $11.52 in 2010, marking five consecutive years of double-digit growth.
For 2011, IBM projects earnings of at least $13 per share. The consensus now targets per-share profits of $13.08 for 2011 and $14.44 for 2012. IBM believes profits can reach $20 per share by 2015. IBM is a Focus List Buy and a Long-Term Buy.
Texas Instruments ($36; TXN) says it will rely on the performance of its analog semiconductors — rather than low prices — to gain market share. That strategy appears to be working. Per-share earnings nearly doubled in 2010, boosted by 34% higher revenue and fatter profit margins. Free cash flow surged 53%. Bookings slipped 9% in the December quarter but improved toward the end of the quarter and remained strong in January. TI issued solid March-quarter guidance, and the consensus now projects 13% growth in per-share earnings.
Much of TI's growth stems from its position in the rapidly evolving markets for smartphones and tablet computers. Research In Motion's ($65; RIMM) upcoming PlayBook tablet uses TI microprocessors. TI says it is also designing a new line of semiconductors that would let smartphone owners shoot 3D movies and surf the Web by pointing fingers at projected images. Gadgets powered by this generation of semiconductors could arrive in time for Christmas 2012. Texas Instruments is a Buy and a Long-Term Buy.