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Wednesday, February 10, 2010

Gabelli and Morgan Stanley go for tech - here's why I agree

Earnings season has nearly run its course and, judging by stock prices, investors seem to be disappointed. Today I'll provide an update to my tech stock earnings scorecard and see what it tells us about the tech sector, where it's been and where it might  be going.

Again, I'll refrain from publishing all the data in tabular form and just provide summaries of a number of measures. Note that I have captured data on 332 stocks  so far and percentages referenced below are based on this total number.

Earnings --
  • 256 stocks beat First Call estimates which amounts to 77%
  • 104 of those stocks beat earnings estimates by 20% or more or almost one third
  • 209 stocks or nearly two thirds showed at least some year-over-year earnings growth whether they beat estimates or not
  • 83 have shown year-over-year growth in earnings of 20% or more
Revenue --
  • 205 stocks have shown year-over-year revenue growth. That amounts to about 62%
  • 78 have shown revenue growth of 20% or more
Guidance --
  • 116 have provided upside guidance which amounts to about 55% of the 209 companies that provided guidance. 
  • 82 others provided mixed or in-line guidance.
  • Only 11 stocks offered downside guidance
My interpretation of the results of this earnings season is that tech is in fine shape. Earnings have been decent to very good. A significant number of companies have shown top-line growth, suggesting that the era of earnings derived solely from cost-cutting is drawing to a close.

More importantly, the outlook from those companies that provided guidance is fairly positive. Very few companies projected poor expectations. This bodes well for the tech sector.

Confirmation --

I am not alone in my enthusiasm for the tech sector. Mario Gabelli's Gamco Investors is also bullish on tech. According to an article on Bloomberg, Gamco's Howard Ward is expecting tech (especially Apple and Google) to rally after technology companies in the Standard & Poor’s 500 Index fell 7.8 percent this year through last week and bearish options on chipmakers rose to the highest level since 2003. Gabelli’s firm says lower valuations will offset more than $560 million of redemptions from global technology funds at the end of January, a 71-week high. You may have noticed that semiconductor ETFs have indeed been recovering lately and one or two showed up on our Swing Trading Signals list on Tuesday.

Also according to Bloomberg, technology stocks, whose 60 percent increase was the biggest among 10 industries in the S&P 500 last year, have slumped 7.8 percent in 2010 for the third-largest decline. This is despite the fact that 256 out of 332 companies that reported since January 11 exceeded analysts’ estimates.

Bloomberg goes on to say "The number of bearish options on the Semiconductor HOLDRs Trust jumped to 1.71 times bullish contracts at the end of January, a six-year high, even though fourth-quarter earnings at S&P 500 companies are poised to rise 78 percent from a year ago, the biggest jump on record, data compiled by S&P and Bloomberg show. Profits are breaking a nine-quarter streak of declines."

As further confirmation of our bullish take on technology, Morgan Stanley estimates that 38 percent of the companies it follows intend to raise capital spending over the next three months, up from a low of 3 percent in August, according to a January 15 survey from the New York-based bank.

Valuations still attractive --

Technology stocks trade at 12.8 times estimated profit for 2011, half the median valuation since 1994, data compiled by Bloomberg show. Technology shares in the S&P 500 trade for 18.5 times profits in the last 12 months, compared with 25.8 when the U.S. market peaked in the fourth quarter of 2007.

So in my opinion, the tech sector is poised to resume its leadership role when stocks come out of the current downturn. Valuations are not exaggerated and forward guidance from company management suggests technology industry fundamentals will continue to improve. This pullback looks to me like a gift - an opportunity to buy tech stocks at reasonable prices.

If you want diversification, there are numerous ETFs available that cover the whole tech sector including, among others, XLK and IYW. If you wish to focus on sub-sectors, there are ETFs for semiconductors (IGW), networking (IGN),  software (IGV), Internet (HHH, FDN) and more. If you are looking for more juice, there are 2x leveraged ETFs from ProShares: ROM is a general tech ETF, USD is the semiconductor ETF and LTL is the telecommunications ETF.

Disclosure: long ROM and USD

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