The increasing optimism on the trading floor this year looks to be spreading, at least into academia. Some economists - often referred to as dismal scientists - now see signs of healthy and long term growth, thanks in large part to the technology sector. Tyler Cowen, economics professor at George Mason University states, "Technological progress comes in batches and it's just a little more rapid than it looked two years ago." Economic forecasters, such as those at Morgan Stanley and IHS Global Insight agree. Said Nariman Behravesh, chief economist at IHS, "There is more optimism about the U.S. and in particular about the second half of this year and 2014. Three months ago, we wouldn't have come to that same conclusion."
So we decided to find good investment opportunities in technology. We started by looking for technology stocks with a history of surprising the market with positive earnings reports, with an average earnings surprise of at least 10% over the last four quarterly reports. Among the results of that screen, we decided to look for companies that appear undervalued. Combined with positive earnings trends, signs of undervaluation may make them suitable investment opportunities.
We narrowed down our list based on each stock's Graham Number. The Graham Number is a measure of maximum fair value based on a stock's EPS and book value per share (BVPS) created by the champion of value investing Benjamin Graham.
Graham Number = SQRT(22.5 x TTM EPS x MRQ BVPS)
The equation assumes that P/E should not be higher than 15 and P/BV should not be higher than 1.5. Stocks trading well below their Graham Number may be undervalued and considered an attractive buy when compared to other defensive criteria.
Just two companies were left on our list that had attractive Graham Numbers: Western Digital Corp. (NYSE:WDC), which operates in the data storage device industry, and Benchmark Electronics Inc. (NYSE:BHE), a player in the printed circuit boards industry.
We decided to further examine these technology companies based on earnings per share, quarterly performance as well as whether they are rallying above their 20-day, 50-day and 200-day moving averages (NYSE:MA), often a sign of strong upward momentum.
For an interactive version of this chart, click on the image below. Average analyst ratings sourced from Zacks Investment Research.
Do you see strong growth potential among these technology companies? Use the list below as a starting point for your own analysis.
1. Western Digital Corp. : Engages in the design, development, manufacture, and sale of hard drives worldwide.
- Market cap at $15.27B, most recent closing price at $63.88
- EPS this year: 112.90%
- EPS next year: -4.60%
- EPS next 5 years: 2.43%
- Performance over the last quarter: 28.02%
- 20-day MA: 2.88%
- 50-day MA: 12.03%
- 200 day MA: 41.98%
- In Jun 2012: Reported EPS at 3.35 vs. estimate at 2.47 (surprise of 35.6%). In Sep 2012: Reported EPS at 2.36 vs. estimate at 2.29 (surprise of 3.1%). In Dec 2012: Reported EPS at 2.09 vs. estimate at 1.82 (surprise of 14.8%). In Mar 2013: Reported 2.1 vs. estimate at 1.77 (surprise of 18.6%. [Average earnings surprise at 18.03%].
- Diluted TTM earnings per share at 7.93, and a MRQ book value per share value at 35.39, implies a Graham Number fair value = sqrt(22.5*7.93*35.39) = $79.46. Based on the stock's price at $63.88, this implies a potential upside of 24.4% from current levels.
- Return since 5/17/2013: 5.66%; compared to Teradata Corporation (NYSE:TDC) (-2.20%), Seagate Technology PLC (NASDAQ:STX) (5.43%) and EMC Corporation (EMC) (2.15%).
Forbes sees more upside to WDC despite the fact that the company has already made significant gains over the last few months. The company's return on invested capital (NASDAQ:ROIC) is high at 40%, and Forbes credits the "intelligent capital allocation capabilities exhibited by its management team," including the recent acquisition of Hitachi Global Storage Technologies (HGST).
And WDC can expect great things from new subsidiary HGST; Vice President for Americas Sales and Channel Marketing Annie Flaig has been named to CRN's 2013 Women of the Channel list, as well as one of this year's Power 100. The annual list recognizes female executives based on accomplishments over the last year as well as their impact on the technology sector in the future. The Power 100 list highlights a subset of these women based on factors such as rank, influence, channel savvy, and exceptional achievements.
2. Benchmark Electronics Inc. : Provides electronics manufacturing services in the Americas, Asia, and Europe.
- Market cap at $1.06B, most recent closing price at $19.43
- EPS this year: 14.90%
- EPS next year: 18.07%
- EPS next 5 years: 10.00%
- Performance over the last quarter: 7.47%
- 20-day MA: 0.19%
- 50-day MA: 6.12%
- 200 day MA: 15.29%
- In Jun 2012: Reported EPS at 0.32 vs. estimate at 0.27 (surprise of 18.5%). In Sep 2012: Reported EPS at 0.31 vs. estimate at 0.3 (surprise of 3.3%). In Dec 2012: Reported EPS at 0.33 vs. estimate at 0.29 (surprise of 13.8%). In Mar 2013: Reported 0.22 vs. estimate at 0.2 (surprise of 10%. [Average earnings surprise at 11.4%].
- Diluted TTM earnings per share at 1.12, and a MRQ book value per share value at 20.97, implies a Graham Number fair value = sqrt(22.5*1.12*20.97) = $22.99. Based on the stock's price at $19.43, this implies a potential upside of 18.31% from current levels.
- Return since 5/17/13: -1.12%; compared to Jabil Circuit Inc. (NYSE:JBL) (-3.14%), Celestica Inc. (NYSE:CLS) (5.57%) and Flextronics International Ltd. (NASDAQ:FLEX) (3.52%).
BHE began in 1979 manufacturing electronic medical products, and has since expanded into many niche markets. The company has been involved with a swallowable live video camera, vending machines for prescription medication, the first portable Braille PDA, as well as complex board assemblies utilized by some of the world's fastest computers.
Last week BHE appointed a new independent director to the company's Board of Directors, Kenneth T. Lamneck. Mr. Lamneck brings extensive experience in technology, as current President and Chief Executive Officer of Insight Enterprises, Inc., a global provider of information technology hardware, software and service solutions. Previously he has worked with Tech Data Corporation and Arrow Electronics.
*EPS and BVPS data sourced from Yahoo! Finance, all other data sourced from Finviz.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Business relationship disclosure: Kapitall is a team of analysts. This article was written by Emily Smykal, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.