The technology sector has been lagging the overall market since the spring of 2012. The sluggish relative performance of the sector coupled with the movement of the relative performance chart into support suggests that the tech sector is worth exploring for investment opportunity. The graphic following shows the Technology Sector ETF (XLK) verse the S&P 500 ETF (SPY).
The macro backdrop:
Technology sector also tends to trade well in the last part of the year. The graphic shows the average monthly return of the XLK and the average level of the XLK relative to January going back to 2003. The value for January is benchmarked to 1.00 on the left axis. Monthly returns are on the right axis. On average, the technology sector seems weakest in January, February, and June, but performs strongly in the spring and firm into year end.
Although the U.S. economy is facing the headwind of higher mortgage rates and fiscal uncertainty due to the debt ceiling saga, purchasing managers surveys out of Europe and China are hinting at a revival in global economic growth. Europe and China have been areas of concern for the business community. Business spending on equipment and software could be positively impacted by the improving growth outlook.
Going into the end of the year, the technology sector may benefit from year end budget flushing and holiday spending on the consumer side. Company spending on productivity enhancing and cost savings measures will likely be in fashion, while electronics may be a strong pick the holiday season given the availability of interesting smart phones and table products.
The technology sector does not have a strong correlation to interest rates and is actually positively correlated to interest rates – it tends to rise if rates rise. The ten year correlation between the 10 year treasury yield and the price of the XLK is +0.258. As a result, the impact of Fed taper on the sector could be limited.
Screening process:
In order to look for opportunities in the technology sector, a screen was set up to find fast growing technology companies at a reasonable price. The screen consisted of three factors: 1) A PEG ratio between 0.80 and 1.20. The PEG ratio measures the price to earnings ratio relative to the growth rate in earnings. A value of 1.0 suggests the PE ratio is equal to the growth rate, while a value below 1.0 indicates that the PE ratio is below the growth rate. Stocks with low PEG ratios are usually seen as possessing value. 2) Earnings per share growth of 10% or more over the past three years. 3) Revenue growth of 10% or more over the past three years.
The picks:
Twelve stocks past the screen, but the screen was further trimmed to include only Zacks Rank #1 (Strong Buy) stocks. Two stocks emerged – Ubiquiti Networks (UBNT) and Syntel (SYNT). Zacks Rank #1 stocks are companies that have strong upward revisions to earnings estimates.
UBNT designs and produces wireless solutions. It is a play on the need for wireless internet access globally. It has a market cap of about $2.8 bln and a PEG ratio of 0.83, which is near the ten year median value of 0.84. It is expected to see EPS growth of 68.5% in FY 2014 (June) and 24% in FY 2015. Sales are expected to grow 50.7% and 21.7% in FY 2014 and FY 2015 respectively.
SYNT is a provider of e-business services. It is involved in customer relations management, data warehousing, business intelligence, and enterprise application outsourcing. It has a market cap of $3.1 bln. Its PEG ratio is 0.91 and it is expected to see EPS growth of 6.7%in 2013 and 5.2% 2014. EPS growth is expected to moderate from the historic pace in the next near before accelerating to 16.6% in 2015. Additionally, the PEG ratio is slightly below the longer term median of 0.93. Sales are projected to rise 12.2% and 11.7% in 2013 and 2014 respectively.
A third possibility:
Another stock to look at is NetQin Mobile (NQ), Zacks Rank #2 (Buy), which is a mobile security and productivity company that is also a cloud play. The company has duel corporate headquarters in Dallas Texas and Beijing, and operates in the small cap space with a market cap of just below $560 mln. Mobile security is finding more attention as the use of smart phones rises and displaces the PC.
NQ is priced with a PEG ratio of 0.64. The company is expected to see rapid growth in EPS in the coming two years. EPS are projected to rise 138% in 2013 and 102% in 2014. Likewise, sales are projected to be robust. Sales are estimated to rise 101% in 2013 and 35% in 2014.
Final thoughts:
If you are looking for a recovery in a lagging market sector, a market sector which is not overly sensitive to interest rates, and stocks with strong growth at a reasonable price, UBNT, SYNT, and NQ may be your plays. Take a look at these names and see if you want to buy yourself a Christmas gift in August.
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