Technology Sector Dashboard - Update

| About: Technology Select (XLK)

Summary

Four key factors are reported across industries in the Technology and Telecom sectors.

They give a valuation status relative to history.

They give a reference for picking stocks in each industry.

This monthly series of articles provides a valuation dashboard in sectors and industries. I follow up a certain number of fundamental factors and compare them to historical averages. This article covers Technology and Telecommunication. The choice of the fundamental ratios used in this study has been justified here and here. You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. A list of stocks to consider is provided in the conclusion.

Methodology

  • Four industry factors calculated by portfolio123 are extracted from the database: price/earnings (P/E), price to sales (P/S), price to free cash flow (P/FCF), return on equity (ROE).
  • They are compared with their own historical averages "Avg". The difference is measured in percentage for valuation ratios and in absolute for ROE, and named "D-xxx" if xxx is the factor's name. For example, D-P/E = (AvgP/E - P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. That's why we take the simple difference: D-ROE = ROE - AvgROE.

The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors.

Industry valuation table on 1/15/2016

The next table reports the four industry factors. For each factor, the next "Avg" column gives its average between January 2001 and October 2015. It excludes the dot-com bubble and may be taken as an arbitrary reference of fair valuation. The next "D-xxx" column is the difference as explained above. So there are 3 columns for each ratio.

P/E

Avg

D- P/E

P/S

Avg

D- P/S

P/FCF

Avg

D- P/FCF

ROE

Avg

D-ROE

Internet

47.43

38.33

-23.74%

3.04

2.93

-3.75%

30.02

29.72

-1.01%

-27

-26.83

-0.17

IT Services

24.83

23.34

-6.38%

1.37

1.16

-18.10%

19.13

18.68

-2.41%

10.61

2.42

8.19

Software

37.81

33.79

-11.90%

3.74

2.81

-33.10%

30.81

23.95

-28.64%

-11.07

-8.17

-2.9

Communications Equipment

31.63

28.48

-11.06%

1.29

1.61

19.88%

22.16

24.1

8.05%

-2.33

-9.61

7.28

Computers & Peripherals

17.78

24.67

27.93%

1.08

1.24

12.90%

21.05

21.68

2.91%

-9.98

-8.33

-1.65

Electronic Equipment

19.15

21.26

9.92%

1.14

1.3

12.31%

18.43

21.35

13.68%

1.04

-1.77

2.81

Semiconductors*

25.09

31.77

21.03%

2.1

2.41

12.86%

27.38

28.86

5.13%

1.05

-1.34

2.39

Diversified Telecom Services

23.1

19.95

-15.79%

1.51

1.2

-25.83%

25.12

23.83

-5.41%

1.02

-11.97

12.99

Wireless Telecom Services

18.25

27.57

33.80%

0.99

1.75

43.43%

25.96

31

16.26%

3.12

-14.25

17.37

Click to enlarge

* Averages since 2003

Valuation

The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better.

Price/Earnings:

Price/Sales:

Price/Free Cash Flow:

Quality (ROE)

Relative Momentum

The next chart compares the price action of the SPDR Select Sector ETF (XLK) with SPY (chart from freestockcharts.com).

Click to enlarge

Conclusion

XLK has outperformed SPY by about 1% in the last 3 months. On this period, the 5 best performing S&P 500 Tech or Telecom stocks are FLIR Systems Inc (NASDAQ:FLIR), First Solar Inc (NASDAQ:FSLR), Harris Corp (NYSE:HRS), KLA-Tencor Corp (NASDAQ:KLAC), SanDisk Corp (SNDK).

All valuation factors have improved since last month, except P/FCF for Computers & Peripherals. Electronic Equipment, Semiconductors and Wireless Telecom Services look attractive: all factors are better than historical averages. Wireless Telecom Services is the best industry in the sector for my metrics. The Software industry is the worst, with all factors in negative territory.

However, there may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. The next table shows a list of stocks in the Technology sector (including Telecommunication). They are all cheaper than their respective industry for the 3 valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity.

This screen updated and rebalanced monthly has an annualized return about 12.76% with a 71% drawdown for a 17-year backtest. The sector ETF XLK has an annualized return of only 2.83% with a 82% drawdown on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding a few trading rules and market timing. This is not investment advice. Do your own research before buying.

CDNS

Cadence Design Systems Inc

SOFTW

EBAY

eBay Inc.

INTERNET

FICO

Fair Isaac Corp

SOFTW

HPQ

HP Inc

COMPUTER

MSTR

MicroStrategy Inc

SOFTW

NSR

NeuStar Inc

TECHSVCE

SAIC

Science Applications International Corp

TECHSVCE

STX

Seagate Technology Plc

COMPUTER

VDSI

VASCO Data Security International Inc

SOFTW

VZ

Verizon Communications Inc

TELECOMDIV

Click to enlarge

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Disclosure: I am/we are long EBAY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.