It’s far better to buy a good company in a great sector than a great company in a bad sector. In other words, invest in companies with tailwinds, not headwinds. That way, even if your investment thesis isn’t spot on, you still stand to make money.
Sounds like a Warren Buffett maxim, I know. But it’s a Louis Basenese original. (At least, I think it is.) It’s so good, in fact, that Buffett’s legal team is probably parsing my words right now.
In the end, I don’t care who gets credit for saying it. All I know is that today, we’re going to put the strategy to work …
Bet Big on Tech
As I shared earlier in the week, retail companies are facing a trio of hurricane-force headwinds. Accordingly, retail qualifies as the proverbial bad sector right now – particularly for brick-and-mortar dominated businesses.
In contrast, the technology sector has nothing but the wind at its back. Case in point: The Federal Reserve Bank of San Francisco’s Tech Pulse Index – which measures the health of investment, consumption, employment, production and shipments in the U.S. tech sector – rose for the 11th consecutive month in January. In December, the Index hit its highest level since 2008.
If you’re reluctant to accept government data at face value, consider the latest from an unbiased third party – Gartner Inc. The tech research firm noted that information technology spending increased 0.4% last year. However, Gartner predicts that total spending will expand by 3.1% in 2014, to $3.8 trillion.
After all, an improving global economy always leads to increased capital spending. And guess what? The favorable tailwinds are already materializing in individual company results.
Beat and Raise
Earnings season unofficially ends today with Wal-Mart’s (NYSE:WMT) report. And after a quick look at the final data, it’s clear that technology stocks are leading the way.
- 81% of tech companies in the S&P 500 Index beat expectations. That compares to 71% for the entire Index, according to FactSet.
- 73% of technology companies beat sales expectations, compared to just 66% for the S&P 500 and 53% for the consumer discretionary sector (which includes retail companies).
- In terms of absolute growth, the technology sector reported the second-highest revenue growth rate (4.6%), led by the internet software and services industry, which delivered 20% growth. And earnings are increasing even faster, up an average of 7.4%.
Not surprisingly, investors are responding to the strong results by bidding up shares. As Bespoke Investment Group notes, technology stocks, along with materials stocks, are enjoying “the strongest one-day gains in reaction to earnings.”
They’re up an average of 1.27%. For tech companies that beat expectations, the average price jumps check in at 2.94%.
Remember, though, these are just the averages. If we look at the Top 25 Best Performing Stocks in the entire market this earnings season, half of them are tech stocks. And they’ve all rallied 20% (or more).
Here’s the good news …
Even after the sharp moves, tech stocks are still downright affordable, trading at a forward price-to-earnings ratio of 15, which represents a 7% discount to their 10-year average multiple.
So how do we go about finding compelling tech stocks to buy? After all, there are almost 2,500 publicly traded ones to choose from.
I’m glad you asked …
A Quick Screen for Winners
I went ahead and set up a screen for “triple plays.” That is, technology companies that beat earnings expectations, beat sales expectations and raised guidance.
They’re obviously benefiting from the strongest tailwinds. On such merits, they’re likely to keep delivering solid results and rewarding shareholders with higher stock prices.
I also limited my search to small caps (i.e., companies with market caps of $2 billion or less).
Why? Because it puts another burgeoning trend on our side – the increase in mergers and acquisitions activity.
A takeover offer represents a surefire way to boost our profit potential by 40% (or more). And I’m pretty certain no one’s going to argue with that.
By no means am I saying all three represent screaming “Buys.” More due diligence is required. But digging into three opportunities sure beats the alternative of individually analyzing thousands of technology stocks.
You can thank me later for the head start.