Valuation Dashboard: Technology - Update

| About: Technology Select (XLK)

Summary

4 key fundamental factors across industries in IT and Telecom.

A valuation status relative to history.

A reference for picking stocks in each industry.

This series provides a valuation dashboard using the GICS classification. Each sector is covered once a month. This issue covers Technology and Telecommunications. It aims at giving reference values for a top-down approach across industries. A list of stocks to consider is offered in the conclusion without detailed analysis.

Methodology

I take 4 aggregate industry factors provided by portfolio123: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). My choice has been justified here and here. Their calculation aims at limiting the influence of outliers and large caps. They are reference values for stock picking, not for capital-weighted indices.

For each factor I calculate the difference with its own historical average: to the average for valuation ratios, from the average for ROE, so that the higher is always the better. The difference is measured in percentage for valuation ratios, not for ROE (already in percentage).

Industry valuation table on 3/28/2016

The next table reports the 4 industry factors. There are 3 columns for each factor: the current value, the average ("Avg") between January 1999 and October 2015 taken as an arbitrary reference of fair valuation, and the difference explained above ("D-xxx").

P/E

Avg

D- P/E

P/S

Avg

D- P/S

P/FCF

Avg

D- P/FCF

ROE

Avg

D-ROE

Internet

42.35

38.33

-10.49%

3.07

2.93

-4.78%

29.22

29.72

1.68%

-28.25

-26.83

-1.42

IT Services

25.74

23.34

-10.28%

1.47

1.16

-26.72%

20.9

18.68

-11.88%

10.52

2.42

8.1

Software

38.85

33.79

-14.97%

3.79

2.81

-34.88%

32.16

23.95

-34.28%

-11.81

-8.17

-3.64

Communications Equipt

36.83

28.48

-29.32%

1.38

1.61

14.29%

18.79

24.1

22.03%

-2.69

-9.61

6.92

Computers & Peripherals

25.54

24.67

-3.53%

1.2

1.24

3.23%

24.72

21.68

-14.02%

-16.76

-8.33

-8.43

Electronic Equipment

22.41

21.26

-5.41%

1.26

1.3

3.08%

22.54

21.35

-5.57%

1.76

-1.77

3.53

Semiconductors*

28.21

31.77

11.21%

2.37

2.41

1.66%

31.69

28.86

-9.81%

2.7

-1.34

4.04

Diversified Telecom Sces

20.98

19.95

-5.16%

1.69

1.2

-40.83%

25.67

23.83

-7.72%

3.62

-11.97

15.59

Wireless Telecom Services

18.3

27.57

33.62%

1.05

1.75

40.00%

39.18

31

-26.39%

8.91

-14.25

23.16

Click to enlarge

* Averages since 2003

Valuation

The following charts give an idea of the current status of industries relative to their historical average.

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 1.5% in the last 3 months. On this period, the 5 best performing S&P 500 Tech or Telecom stocks are CenturyLink Inc (NYSE:CTL), FLIR Systems Inc (NASDAQ:FLIR), Hewlett Packard Enterprise Co (NYSE:HPE), Symantec Corp (NASDAQ:SYMC), Verizon Communications Inc (NYSE:VZ). VZ has hit an all-time 2 weeks ago.

Since last issue, most industry factors are stable. We note an improvement in ROE for Wireless Telecom services and in P/E for Diversified Telecom Services. However, the latter shows a degradation in P/FCF. The Computers and Peripherals industry has degraded in P/FCF and ROE.

This month, no industry is above the baseline for all factors. Wireless Telecom Services, Semiconductors and Communication Equipments have 3 factors out of 4 better than the historical average. Once again, the Software industry is the only industry with all factors below historical averages.

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 strategy 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.

CATM

Cardtronics Inc

TECHSVCE

CRUS

Cirrus Logic Inc.

SEMIANDEQUIP

HPQ

HP Inc

COMPUTER

LDOS

Leidos Holdings Inc

TECHSVCE

MU

Micron Technology Inc.

SEMIANDEQUIP

NSR

NeuStar Inc

TECHSVCE

SAIC

Science Applications International Corp

TECHSVCE

SANM

Sanmina Corp

ELECTREQUIP

SYNA

Synaptics Inc

SEMIANDEQUIP

VDSI

VASCO Data Security International Inc

SOFTW

Click to enlarge

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Data provided by portfolio123. Technology Valuation Click to enlarge

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.