Quadrix Taps Into Technology

9/19/2011


Technology companies are fun to follow, and tech stocks — with their rapid growth rates and high returns — can be fun to own.

In the 12 months ended June, the S&P 1500 Technology Sector Index’s per-share profits jumped an estimated 32%, versus 25% for the broader S&P 1500 Index. As the chart below illustrates, the tech index grew profits at annualized rates of 15% over the last five years and 23% over the last 10, versus respective rates of 3% and 7% for the S&P 1500.

But as surfers will tell you, the warmest water tends to contain the most sharks.

Since 1992, for the 223 rolling 12-month periods ended June, technology stocks in the Dow Jones U.S. Index averaged total returns of 19.1%, the highest of any sector. However, much of that return derived from a relatively small number of very strong performers, as the average of median returns was 7.0%. By definition, half of the returns in a data set are above the median and half are below. Outliers — unusually high or low numbers — have less effect on medians than averages.

Technology stocks are known for their volatility. No other sector had anywhere near the 12-percentage-point spread between average and median returns. That disparity should not scare investors away from a high-growth sector, but it illustrates the risks of investing in technology and the importance of focusing on the sector’s most attractive stocks.

Fortunately, Quadrix can provide plenty of help. On average, tech stocks in the Dow Jones U.S. Index with Overall scores in the top one-fifth have averaged 12-month returns 2.5% higher than those of the average tech stock since 1992. While the Overall score had predictive power in nine of the 10 sectors, it was most effective in tech. The Overall score works for both the software & computer services and hardware & equipment groups within the index, although the Quadrix category scores perform differently.

Eight individual Quadrix factors have sufficient predictive power that the top one-fifth of tech stocks as measured by each factor outperformed the average by at least 5%. Five of those eight are Value factors, with three measuring value relative to historical norms. Beleaguered tech giant Hewlett-Packard ($23; HPQ) looks especially cheap based on the relative-valuation metrics, with Intel ($21; INTC) and Oracle ($28; ORCL) also cheap relative to their history.

Also among the top eight factors are estimate-revision trends, for which Apple ($385; AAPL) and Microsoft ($26; MSFT) stand out, and long-term expected profit growth, another strong point for Apple.

STRONG TECH STOCKS
Below are all 14 of the technology stocks we rate A (above average). Stocks recommended for purchase are presented in bold.
12-Month
Growth
P/E Ratio
Quadrix
Scores
Company (Price; Ticker)
Stock-
Market
Value
($Bil.)
Sales
(%)
Per-
Share
Profits
(%)
Trailing
Vs.
5-Yr.
Median
Value
Overall
Subindustry
Adobe Systems
($25; ADBE)
12.7
24
141
11
0.41
82
93
Software
Altera
($37; ALTR)
12.2
42
67
13
0.66
65
88
Semicond.
Apple
($385; AAPL)
360.7
76
91
15
0.70
65
99
Hardware
Applied Mats.
($11; AMAT)
14.7
37
147
8
0.46
95
95
Semicond.
BMC Software
($40; BMC)
7.2
10
15
13
0.61
71
81
Software
Dell ($14; DELL)
26.9
6
94
7
0.52
95
99
Hardware
EMC ($22; EMC)
49.6
19
37
16
0.64
55
68
Hardware
Google
($530; GOOG)
172.6
27
27
16
0.58
52
94
Internet
Hewlett-Packard
($23; HPQ)
47.2
4
12
5
0.32
99
62
Hardware
IBM ($163; IBM)
199.6
7
20
13
0.94
52
82
Services
Intel ($21; INTC)
113.0
18
23
9
0.53
89
97
Semicond.
Microsoft
($26; MSFT)
221.9
12
27
10
0.65
85
98
Software
Oracle
($28; ORCL)
143.1
33
34
12
0.62
69
93
Software
Qualcomm
($52; QCOM)
89.4
25
20
17
0.72
40
80
Telecom Eq.
Note: Quadrix scores are percentile ranks, with 100 the best.

The table above lists our 14 A-rated technology stocks. Three are reviewed below.

Apple ($385; AAPL) shares have surged 19% in the past year, versus the S&P 500 Index’s 7% decline. Profit estimates for the September and December quarters have risen at least 9% over the last two months and now project year-to-year growth of 51% and 35%. Apple’s efforts to expand its presence in China should help sustain growth. It is preparing to launch a new iPad, sell the iPhone through additional carriers, and open a retail store in Hong Kong.

Apple boasts outstanding trends for both recent operating momentum and long-term growth. It is also reasonably valued, trading 8% below the five-year average based on price/sales and 43% on price/earnings. With an Overall score exceeding 95 in each of the last 12 months, Apple is a Focus List Buy and a Long-Term Buy.


IBM ($163; IBM) has delivered annualized per-share-profit growth of 17% over the last five years, versus 4% for the previous five years. Double-digit profit growth should continue in coming years. Sales growth has accelerated in each of the last four quarters, and IBM sees itself ahead of schedule for reaching its goal of $20 in per-share profits by 2015, up from $11.52 last year. These strengths all factor into IBM’s persistently high Overall score, which has ended above 80 for 24 straight months.

Shares have pulled back from their all-time high near $186 in July but remain up 11% for the year. The consensus 2011 estimate targets per-share earnings of $13.31, implying 16% growth. Despite IBM’s consistent growth, favorable outlook, and leading market position, the stock trades at just 12 times that 2011 estimate, a 12% discount to the tech sector median. IBM is a Focus List Buy and a Long-Term Buy.


Intel’s ($21; INTC) price/sales ratio — one of the most effective metrics for predicting outperformance in technology stocks — has dipped to 2.3, near its decade low of 1.9 and 28% below its five-year median of 3.1. The shares have held up fairly well so far this year, down 1% compared to the S&P 500’s 7% decline.

Despite waning personal-computer demand in developed markets, Intel should experience strong near-term growth. Per-share profits are projected to rise 17% in the September quarter and 10% in the December quarter, with revenue growth of more than 25% in both periods. Looking further out, Intel stands to benefit from the $7.68 billion McAfee acquisition completed in February. McAfee’s security software is starting to turn up in smartphones made by Apple and Sony Ericsson.

The software could become a leading player in a burgeoning market as mobile devices become ever more functional for consumers — and increasingly enticing targets for thieves and hackers. Also, Intel is reportedly among the companies interested in acquiring InterDigital’s ($64; IDCC) patent portfolio, potentially worth more than $5 billion. Yielding 4.0%, Intel is a Buy and a Long-Term Buy.

SECTOR AND INDUSTRY-GROUP AVERAGES
12-Mo. Chg.
P/E Ratio
Total Return
Quadrix Scores
Group (No. Of Companies)
Sales
(%)
Per-
Share
Profits
(%)
Trailing
Vs.
5-Yr.
Median
3-
Month
(%)
YTD
(%)
Momen-
tum
Value
Quality
Overall
12-Factor
Sector
Reranked Overall
Technology (163)
20
29
22
0.71
(12)
(10)
54
56
70
63
52
53
  Soft. & Comp. Svcs. (64)
18
23
33
0.75
(10)
(5)
62
45
73
63
44
51
    Computer Svcs. (11)
13
9
19
0.79
(11)
(3)
53
57
75
64
54
54
    Internet (9)
13
14
23
0.64
(9)
(12)
57
52
64
61
38
48
    Software (44)
20
28
38
0.76
(11)
(5)
65
40
74
62
43
51
  Hardware & Equip. (99)
22
34
15
0.69
(13)
(14)
49
63
68
62
56
53
    Comp. Hardware (18)
15
26
15
0.68
(9)
(7)
57
70
65
70
70
58
    Elec. Office Equip. (2)
12
7
8
0.70
(14)
(22)
26
90
47
50
63
29
    Semiconductors (50)
25
39
14
0.67
(15)
(14)
48
66
76
68
56
59
    Telecom Equip. (29)
20
33
20
0.71
(12)
(15)
48
50
58
50
47
42
Notes: Averages exclude growth rates and total returns above 200%.   Quadrix scores are percentile ranks, with 100 the best.   The 12-Factor Sector and Reranked Overall scores are designed to rate technology stocks relative to other technology stocks. Scores are not available for all stocks in the Dow Jones U.S. Index.

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