Is It Time To Sell Technology Stocks?

| About: Technology Select (XLK)

It is always difficult to time the market on a short term basis. Sometimes it is best to act as a long term investor, possibly picking a few cyclically relevant periods within the year to buy or sell stocks. However, when stocks record major gains within a short period of time, one cannot but wonder whether the market has possibly overextended itself.

In a recent article we published on 3/4/3012, "5 technology stocks that can get a boost from the economy", we outlined the positive prospects for five large capitalization technology stocks: Intel, Inc. (NASDAQ:INTC), International Business Machines (NYSE:IBM), Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT) and Cisco Systems, Inc. (NASDAQ:CSCO). At the same time, we compiled our own market capitalization weighted index for such five stocks, Big5TekTM. As of 3/2/2012, Big5TekTM was up 21.6% year-to-date at 121.56, and when adjusted for dividends, it was up 22%. Less than 2 weeks later, as of 3/14/2012, Big5TekTM is up 27.3% year-to-date at 127.3, and when adjusted for dividends, it is up 27.7%.

Stock Price Change (Year-to-Date)

Company Price as of 12/30/2011 Price as of 3/2/2012 YTD Percent Change
as of 3/2/12
Price as of 3/14/2012 YTD Percent Change
as of 3/14/12
Cisco 18.02* 19.76 +9.66% 20.20 +12.10%
Microsoft 25.79* 32.08 +24.39% 32.77 +27.06%
Intel 24.06* 26.92 +11.59% 27.46 +14.13%
IBM 183.17* 198.81 +8.54% 204.72 +11.77%
Apple 405* 545.18 +34.6% 589.59 +45.58%
Big5TekTM 99.66** 121.56 +22% 127.3 +27.7%
*Price adjusted for splits and dividends. Source: Yahoo Finance
**Price adjusted for splits and dividends.

Every single stock in the Big5TekTM has appreciated since 3/2/2012, although Apple has appreciated the most, currently up 45.6% year-to-date. With recent analyst price upgrades for Apple, in addition to a strong economy, we still believe that from a long term perspective, the prospects for these five stocks still look good. As a matter of a fact, in an article we published on 2/21/2012, "3 indications Apple shares haven't peaked yet", when Apple was at $502.21, we indicated a price target of $620 for Apple, with momentum possibly carrying it to $750. However, given the substantial 27.7% gain in the index, and ahead of the upcoming earning season, does it make sense to book some profits for the time being?

Typically, when companies are about to miss on their earnings estimates, they would provide a warning prior to the release of such earnings. For most companies, the end of their current quarter is 3/31/2012. Hence, it is possible that any earnings warnings would come sometime between the last two weeks in march and the first week in April. If such warnings were major, it is possible the entire market can move lower ahead of earnings, even for companies with no scheduled earnings release. To test such hypothesis, we examined the price action of these five technology stocks between March 14 and April 7 for the past 5 years, knowing that there would also be other factors affecting such prices.

Stock Price Change
March 14 to April 7 for Years 2007 to 2011
Average Change Number of Up Periods Average Change for Up Periods Number of Down Periods Average Change for Down Periods
CSCO +2.04% 4 +2.94% 1 -1.56%
MSFT +4.71% 5 +4.71% 0 0.00%
INTC +2.77% 4 +4.44% 1 -3.78%
IBM +3.74% 5 +3.74% 0 0.00%
AAPL +10.00% 4 +13.60% 1 -4.38%
Average: +4.65% +5.88% -3.28%

From a cyclical perspective, it does seem that during the past five years, the large capitalization technology stocks examined increased by an average of 4.65% between March 14 and April 7. In addition, when excluding the years during down periods, such average was 5.88%.

From a long term perspective, given continued economic strength, it does not seem it makes sense to sell technology stocks at this stage ahead of possible earnings warnings. Although past performance is no indication of future performance, had investors sold such stocks on March 14 and repurchased them on April 7 during the past 5 years, investors would have given up an average of about 4.65% in upside potential.

From a fundamental perspective, such stocks have also witnessed an expansion in their forward PE ratios:

Forward PE Ratios
Current Fiscal Year Forward PE Ratio* Next Fiscal Year Forward PE Ratio*
CSCO 11.04 10.25
MSFT 12.18 10.89
INTC 11.39 10.21
IBM 13.72 12.44
AAPL 13.72 12.27
Average: 12.41 11.21
*Forward PE Ratios were calculated from Expected Earnings provided by Yahoo Finance

However, despite the increase in such PE ratios, it should be noted that some analysts earnings expectations are still lagging behind, and we may see upward revisions to earnings expectations, which may in turn cause the forward PE ratios to drop. We have recently witnessed such revisions for Apple Inc. by Morgan Stanley and others.

In addition, as stated in our article published on 3/9/2012, "3 reasons tech could drive the NASDAQ 100 to 3,000", this is still substantially below the PE ratio historical average of 16.2 for the S&P500. Although technology should possibly have a lower PE ratio than the S&P500 average, it would be expected to lag by about 1.5% to 3.0% as opposed to 4%.

Given expectations for a continued robust economy, reasonable PE ratios and cyclically favorable stock price environment, technology investors in these five stocks may want to maintain their long term positions despite the recent robust increase in their stock prices.

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

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