Valuation Dashboard: Technology - Update

| About: Technology Select (XLK)
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Summary

Valuation metrics in Information Technology and Telecom.

Evolution since last month.

A list of stocks looking cheap in their industries.

This article series provides a monthly dashboard of industries in each sector of the GICS classification. It compares valuation and quality factors relative to their historical averages in each industry, and gives a list of 10 stocks. I update every month 8 lists like this one covering all sectors (some sectors are grouped). The 8 lists together have returned about 25% in 2016. If you want to stay informed of updates, click "Follow" at the top of this page. My Marketplace Subscribers have an early access to the stock lists before they are published in free-access articles.

Executive summary

The hardware industry is undervalued regarding price/earnings and a bit overpriced for 2 other valuation factors. Communication Equipment looks very close to fair value. Internet is moderately over-priced. Wireless Telecom Services are overpriced, but the price-to-sales ratio and profitability (measured by ROE) are better than historical averages. Other industries are less attractive. The most overpriced is Diversified Telecom Services. All industries in the sector are above or close to the historical average in profitability.

Since last month:

  • P/E has improved in Internet, Communication Equipment, Diversified Telecom Services and deteriorated in Semiconductors, Wireless Telecom Services.
  • P/S has improved in IT Services, Diversified Telecom Services and deteriorated in Communication Equipment, Internet, Hardware/Peripherals.
  • P/FCF has improved in IT Services, Hardware, Peripherals, Diversified Telecom Services and deteriorated in Communication Equipment.
  • ROE has improved in Communication Equipment and deteriorated in Internet.
  • The SPDR Select Sector ETF (XLK) has outperformed SPY by about 2% in 1 month.
  • On this period, the 5 best performing S&P 500 Tech or Telecom stocks are Broadcom Ltd (NASDAQ:AVGO), Microchip Technology Inc (NASDAQ:MCHP), Qorvo Inc (NASDAQ:QRVO), Seagate Technology Plc (NASDAQ:STX), Skyworks Solutions Inc (NASDAQ:SWKS). AVGO and MCHP hit an all-time high in the last few days.

Some cheap stocks in their industries

The stocks listed below are in the S&P 1500 index, cheaper than their respective industry factor for Price/Earnings, Price/Sales and Price/Free Cash Flow. The 10 companies with the highest Return on Equity are kept in the final selection.

This strategy rebalanced monthly has an annualized return about 12.76% in a 17-year simulation. The sector ETF XLK has an annualized return of only 2.83% on the same period. Past performance is not a guarantee of future result. This is not investment advice. Do your own research before buying.

ACIW

ACI Worldwide Inc

SOFTW

ARW

Arrow Electronics Inc

ELECTREQUIP

BDC

Belden Inc

ELECTREQUIP

CA

CA Inc

SOFTW

CVG

Convergys Corp

TECHSVCE

HPQ

HP Inc

COMPUTER

NSR

NeuStar Inc

TECHSVCE

SAIC

Science Applications International Corp

TECHSVCE

SANM

Sanmina Corp

ELECTREQUIP

SNX

SYNNEX Corp

ELECTREQUIP

Detail of Valuation and Quality indicators in Technology and Telecom on 2/9/2017

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).

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

45.53

38.33

-18.78%

3.44

2.93

-17.41%

29.7

29.72

0.07%

-20.17

-26.83

6.66

IT Services

27.11

23.34

-16.15%

1.59

1.16

-37.07%

22.38

18.68

-19.81%

7.67

2.42

5.25

Software

46.38

33.79

-37.26%

3.86

2.81

-37.37%

33.81

23.95

-41.17%

-6.88

-8.17

1.29

Communications Equipt

31.29

28.48

-9.87%

1.63

1.61

-1.24%

21.85

24.1

9.34%

-3.17

-9.61

6.44

Hardware, Peripherals

18.58

24.67

24.69%

1.49

1.24

-20.16%

22.58

21.68

-4.15%

-9.14

-8.33

-0.81

Electronic Equipment

27.93

21.26

-31.37%

1.41

1.3

-8.46%

28.33

21.35

-32.69%

1.38

-1.77

3.15

Semiconductors*

40.94

31.77

-28.86%

3.03

2.41

-25.73%

30.05

28.86

-4.12%

2.13

-1.34

3.47

Diversified Telecom Sces

35.31

19.95

-76.99%

1.57

1.2

-30.83%

34.03

23.83

-42.80%

-5.49

-11.97

6.48

Wireless Telecom Sces

47.66

27.57

-72.87%

1.45

1.75

17.14%

37.91

31

-22.29%

-0.36

-14.25

13.89

* Averages since 2003

The following charts give an idea of the current status of 3 valuation factors (P/E, P/S, P/FCF) and a quality factor (ROE) relative to their historical average in each industry. For all factors the difference to average is calculated in the direction where positive is good. For valuation ratios lower is better, for ROE higher is better. On the charts below higher is always better.

Price/Earnings relative to historical average:

Price/Sales relative to historical average:

Price/Free Cash Flow relative to historical average:

ROE relative to historical average:

Momentum

The next chart compares the price action of XLK with SPY in the last 3 months (chart from freestockcharts.com).

If you want to stay informed of my updates on this topic and other articles, click the "Follow" tab at the top of this article.

Data provided by portfolio123 (this is a partner link giving you an extended period of free trial. I may receive a fee if you buy later a paid subscription, at no additional cost to you).

Disclosure: I am/we are long CA, SPY.

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.