7 Cheap Technology Stocks Breaking Out

by: Alan Brochstein, CFA

Technology has been the best place to be so far in 2012, up almost 16%, almost double the S&P 500's 9% price return. While many might quickly dismiss this as solely a reflection of the meteoric rise in Apple (NASDAQ:AAPL), the strength is quite broad. In fact, as I pointed out a few weeks ago, AAPL isn't the top dog. At that time, AAPL was in 16th place out of 71 S&P 500 Technology stocks. With the recent surge (to overbought levels in my view), it's now in 6th place. By my calculation, if AAPL, which is currently about 20% of the Technology component of the index were excluded, tech stocks would still be up more than the S&P 500. 2/3 of the stocks in the sector are up more than the market so far in 2012.

To me, it looks like the train has left the station, but I think that there are still lots of stocks in the sector where it's likely not too late to climb aboard. One thing I have learned over the years is not to buy tech stocks just because they are cheap. In this sector, a rising tide doesn't lift all boats (sticking with the transportation analogies). So, with this in mind, I wanted to identify some cheap stocks that are "working" technically and fundamentally. Here is the screen I ran on tech stocks in the Russell 3000, using Baseline:

  • <10% below 52-week high
  • 1-Year Price Return <10% (S&P = 3%)
  • 2-Year Price Return < 30% (S&P = 20%)
  • Forward PE < 12
  • Trailing EPS Growth > 0

Summarizing these parameters, the stock is pretty close to the 52-week high but not too extended (given the price return constraints). The PE is low, but the fundamentals are alright, as evidenced by earnings growth. Here are the 7 stocks that made the cut, sorted by market cap (click to enlarge image):

I hold two of these stocks in my Top 20 Model Portfolio: Cisco (NASDAQ:CSCO), which is also in my Conservative Growth/Balanced Model Portfolio, and TechData (NASDAQ:TECD), so I can address them with a bit more insight than the rest. I like both of these stocks at the current prices - for the rest, I am not necessarily recommending them.

CSCO was unfairly penalized a year ago as investors mistook poor market conditions for company-specific fundamental challenges. Still, the company wasn't doing things as well as it could, and CEO Chambers rose to the challenge in my view. The stock has been posting new 52-week highs but remains well below its April 2010 highs. The valuation is obviously low, especially if one takes into account the hoard of cash and investments (>$5 per share). Even more conservatively, one can strip away the deferred revenue, and there is still over $3 per share. Earnings estimates have been rising for both FY12 and FY13. I think that CSCO can get to 28.50 over the next year based on attaining 12.5 PE (and adding back $3 of cash net of debt and deferred revenue).

TechData reported a solid quarter this past week, which was impressive given that more than half their sales come from Europe. Like AVT, as a distributor, TECD is a lazy way to play technology given the diversification. With that said, though, I think the company is extremely well-managed (I have closely followed them for more than a decade). The company shared conservative guidance in my view, taking into account macro headwinds, currency shifts and the impact of divestiture of operations in Brazil and Colombia, prompting some profit-taking from a multi-year high. TECD has a fortress balance sheet despite massive repurchases over the past few years, with almost $10 per share net of debt. With a single-digit PE and only a 12% premium to tangible book value, the stock is very cheap in my view. I raised my target after the Q4 report to 79, based on attainment of 12.5 PE a year out.

CA (NASDAQ:CA) is the best stock on the list so far in 2012, rising sharply in January when it quintupled its dividend (to $1 per share) and jacked its share repurchase authorization (with a $500mm accelerated buy).

Avnet (NYSE:AVT) has the lowest PE, but note that it is also the only stock with net debt. As a distributor of semiconductors, components and servers, the stock offers investors a very diversified way to play the overall sector. I prefer TECD (see below).

Amdocs (NYSE:DOX) has traded in a pretty tight range for the past 27 months or so. The company, based in Guernsey with headquarters in Missouri, is a provider of software and services to service providers. It has repurchased 20% of its stock over the past 7 quarters and still has almost $1 billion of cash on the balance sheet. Analysts project 5% top-line growth through 2013.

QLogic (NASDAQ:QLGC) seems like a dead company to me, but it has the parameters to qualify for inclusion. Analysts project flat sales for the next year for this maker of networking components. While it hasn't grown the top-line in five years, it has used cashflow to massively shrink the share-count. With its recent sale of its InfiniBand business, it has plenty of fuel (>$500mm) to continue to buy back stock.

J2 Global (NASDAQ:JCOM) has traded in a tight range for the past two years and sits not too far below the all-time highs from 2007. Earnings, on the other hand, have extended sharply from the levels of a few years ago but are projected to be just flat in 2012 and to rise slightly in 2013. The company provides fax and messaging services.

So, tech is hot, and most of the names in the sector, including several of these, are beating the market so far in 2012. The screen I shared is designed to identify companies with reasonable technical set-ups (consolidations with potential breakout or recent breakout) and whose valuation is reasonably low, supported by stable or strong fundamentals. I certainly like CSCO and TECD, and several of the other stocks merit further investigation.

Disclosure: CSCO and TECD are included in model portfolios at Invest By Model