Alan Brochstein Investigates Large-Cap Technology Stocks

October ended a run of four months of positive monthly closes for the S&P 500, with the price declining 2%. One of the contributing factors was extreme weakness in Technology, which fell 6.32%. Since the sector is such a large part of the index (20% as of 9/30/12), the decline was responsible for the majority of the overall market decline. Despite the correction, Technology is still slightly ahead of the market, up 13.0% compared to the 12.3% rise in the S&P 500 through 10/31.

This is normally a seasonally strong time of the year for Technology, from November through April. With the recent pullback, the sector could offer value. According to the Standard & Poors website, the sector may grow earnings in 2013 by 18%, substantially above the 13% estimate for the overall market. Despite this potentially higher expected growth, the valuation is modestly cheaper, according to S&P, with the Tech sector valued at 11.5X 2013 earnings compared to 12.4X for the overall market. What makes this even more interesting is that many Technology companies have substantial cash rather than debt, which could mean the valuation may be even more attractive.

Given the combination of better growth and lower valuation along with favorable technical trends, I thought it might make sense to screen the sector for some new ideas. My goal was to find some names with good valuations, reasonable fundamentals and near-term favorable price momentum. Here are the parameters I employed:

·       Member of S&P 500 (70 companies)
·       Forward PE < 15X (38 companies)
·       2013 projected EPS growth > 10% (17 companies)
·       October Return > -2% (5 companies)

Here are the 5 that made the cut:
 


The companies that made the list aren’t recommendations. As always, you should do your own investigation before purchasing any stock.

I have sorted the list by forward PE, from lowest to highest. I have also included some additional information. First, note that 3 of the 5 have little or no net debt (shaded in green). I also included the YTD price change, with the first three outperforming so far in 2012, one underperforming and one matching the overall market. Finally, note that 3 of the 5 trade below their 5-year average PE (shaded in green).

BMC Software (BMC), which recently hired an investment banker to explore its strategic options, announced a $1 billion share repurchase authorization at the end of October after spending $350mm in the six months ending 9/30/12 to buy back 8.3mm shares. The company provides IT management solutions for both mainframe and distributed applications and databases, with half of their sales coming from recurring maintenance and service contracts.

Fidelity Information Services (FIS) provides banking and payments technologies, dealing with 14K customers in over 100 countries. When they reported their Q2 results in July, they indicated that their organic sales growth would be 3-5% in 2012.  This company has substantial debt, which exceeds $4 billion after subtracting cash.

Fiserv (FISV) also provides banking and payments technologies and has substantial debt ($3.5 billion). The company reported earnings in late October and reiterated its view that internal revenue growth would be 3-4.5% for 2012. It’s sales and earnings growth has been steady over the years, increasing even in 2009. Like BMC and FIS, FISV has been reducing its share-count through repurchases. It also pays a 2.4% dividend.

Unlike the first three, Lam Research (LRCX) is a hardware company, selling equipment to the semiconductor industry. It recently acquired its long time rival, Novellus, effectively doubling the company. The company shared very cautious guidance when it reported its Q2 in October, suggesting that its customers are reducing their spending outlooks, but the stock rallied on the bad news. The company has about $7.50 per share in cash net of debt.

Motorola Solutions (MSI), which makes communication infrastructure and devices (two-way radios), is engaged in a proxy battle with Value Act, which just agreed to limit its ownership to 12.5 after being able to appoint two directors to its Board of Directors. The company reported its Q3 in late October and raised its outlook substantially. Its dividend yields about 2%.

In stark contrast to twelve years ago, technology stocks are among the least expensive in the market. It is the largest sector in the market and offers some great attributes, including global exposure, growth, strong balance sheets, market dividends or higher for many companies and reasonable valuations. The screen today is designed to identify some potential opportunities within the sector that offer a combination of favorable fundamental, valuation and technical characteristics.

Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  No positions in any stocks mentioned

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