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 4/19/2016

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

44.21

38.33

-15.34%

3.16

2.93

-7.85%

29.05

29.72

2.25%

-29.63

-26.83

-2.8

IT Services

27.31

23.34

-17.01%

1.57

1.16

-35.34%

20.94

18.68

-12.10%

10.3

2.42

7.88

Software

40.2

33.79

-18.97%

3.79

2.81

-34.88%

33.3

23.95

-39.04%

-10.82

-8.17

-2.65

Communications Equipt

32.17

28.48

-12.96%

1.4

1.61

13.04%

18.73

24.1

22.28%

-2.37

-9.61

7.24

Computers & Peripherals

24.67

24.67

0.00%

1.23

1.24

0.81%

22.7

21.68

-4.70%

-15.65

-8.33

-7.32

Electronic Equipment

22

21.26

-3.48%

1.27

1.3

2.31%

23.57

21.35

-10.40%

1.97

-1.77

3.74

Semiconductors*

27.92

31.77

12.12%

2.36

2.41

2.07%

29.35

28.86

-1.70%

2.96

-1.34

4.3

Diversified Telecom Sces

22.39

19.95

-12.23%

1.7

1.2

-41.67%

26.34

23.83

-10.53%

4.91

-11.97

16.88

Wireless Telecom Sces

19.48

27.57

29.34%

1.10

1.75

37.14%

40.82

31

-31.68%

6.58

-14.25

20.83

* 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).

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 Applied Materials Inc. (NASDAQ:AMAT), Amphenol Corp (NYSE:APH), CenturyLink Inc (NYSE:CTL), Frontier Communications Corp (NASDAQ:FTR), Hewlett Packard Enterprise Co (NYSE:HPE). APH is close to an all-time high.

Since last month:

  • P/E is stable for Semiconductors, Electronic Equipment and Computers, and has deteriorated in other industries.
  • P/S is stable in all groups.
  • P/FCF has improved in Semiconductors and Computers.
  • ROE has improved in Diversified Telecom Services and deteriorated in Wireless Services.

Semiconductors and Communication Equipments are the most attractive groups. They look fairly valued or slightly underpriced and are above the baseline in quality. Telecom industries are above their average ROE, which may offset mixed valuation factors. The Software industry looks the worst, with all factors below the baseline.

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

NSR

NeuStar Inc

TECHSVCE

SAIC

Science Applications International Corp

TECHSVCE

SANM

Sanmina Corp

ELECTREQUIP

STX

Seagate Technology Plc

COMPUTER

VDSI

VASCO Data Security International Inc

SOFTW

VZ

Verizon Communications Inc

TELECOMDIV

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Data provided by portfolio123.

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.