This is not a good time to be running a tech company.
Major corporate clients continue to withholdcapital
spendingfunds ,investing only in areas that promise rapid
paybacks or can be improved with a modest amount ofmoney .
Moreover, the U.S. government, which is a major buyer of
hardware, software and services, has nearly frozen, as the
sequester limits -- or even shrinks -- information technology
budgets. Adding insult, foreignsales divisions at tech firms in
Europe and Asia are noting a high degree of spending caution.
How bad are business conditions? Based on updated
second-quarterguidance , tech companies are expected to post a
5%revenue drop in the current quarter compared with ayear ago,
according to Bloomberg. With the exception of a fewquarters in
late 2008 and early 2009, we haven't seen a drop like that since
the dot-com implosion.
In response, major institutional investors have been steadily
reducing their exposure to this struggling sector. Even as the
S&P 500 has risen 13% since Labor Day, the
SPDR Select SectorFund TechnologyETF (
has not appreciated at all.
Counterintuitively, the rotation out of techstocks creates a
compelling opportunity. Though this sector is beset by near-term
challenges, results should start to rebound later this year.
In most years, companies' chief information officers (CIOs)
are allocated a certain portion of funds to work with. They often
aim to spread out spending evenly over the course of a year, but
every few years, spending gets off to a slow start as caution
builds. However, CIOs know that when it comes to annual budgets,
they must use it or lose it, and spending could spike sharply as
we head into the fourth quarter.
That phenomenon, known as a "budget flush," was very
pronounced most recently in 2009, as IT spending started off on a
dismalnote but finished with a bang. Notably, the SPDR Select
Sector Fund Technology ETF got off to a slow start in 2009 but
finished the year with a 51%gain (compared with a 23% gain for
the S&P 500).
Of course, we can't say for sure that global economic
conditions won't weaken further this year, so a budget flush is
not a given. Yet the primary reason for IT spending by both
governments and enterprises is that it's a greatproductivity
The U.S. government, for example, aims to deliver the same
level of services with a reduced workforce, and the only way to
do that is through technology-driven productivity increases. So
deferred tech spending now should lead to a catch-up period
The relative underperformance of tech stocks has made them
among some of the top bargains in themarket . Many trade for only
10 to 12 times forward profits, and when you back out robustcash
levels, thosemultiples fall into the single digits.
Apple (Nasdaq: AAPL)
is a great example of a cash-adjusted bargain:Shares trade for 10
timesforward earnings , but less than 8 times when cash is
Cheap (and Deservedly So)
In this sector, it's not wise to seek out the most inexpensive
stocks. These are the only tech stocks in the S&P 500 that
trade for less than 10 times projected profits, yet almost all of
them are beset by company-specific woes that are unlikely to
dissipate, even when tech spending rebounds.
In this group, only
holds appeal, due to its stunningfree cash flow . I'm also a fan
Jabil Circuit (
for its outstanding management, but its hefty international sales
exposure could be a problem in coming quarters. Keep an eye on
this stock: If it moves into the lower teens (from its current
$17.50), it would be a great long-term value.
If you move up to the nextwave of inexpensive tech stocks,
then you have a better chance of latching on to companies
thatwill more squarely benefit from the eventual IT spending
rebound. These tech stocks all trade for less than 13 times the
projected profits for their currentfiscal year .
In December, I named
Cisco Systems (Nasdaq: CSCO)
my top tech pick of 2013, and I remain a big fan.
Additionally, any time that stocks like
Oracle (Nasdaq: ORCL)
are feeling the pressure of a weak recent quarter, that's often
proved to be a good entry point, as these market dominators have
proved to snap back nicely once the trough passes.
Of course, another major theme among tech stocks is their
stunning cash balances and robust free cash flow. It's no
coincidence that these are the companies leading the charge
interms of hugestock buybacks and soliddividend hikes. (In fact,
our focus on the "
" often finds us talking about tech stocks.) Here's a quick look
at the most cash-rich tech companies in the S&P 500, in the
context of their market values.
To reiterate, these stock's price-to-earnings (P/E ) ratios
drop sharply when calculated on a cash-adjustedbasis . The
current rotation out of tech stocks gives these companies a
chance to more aggressively deploy their cash into highly
accretive stock buybacks.
Risks to Consider:
It's tricky to find a bottom for this sector, and the
year-end budget flush may not play out if the globaleconomy
stumbles, so you should own these stocks with a multi-year time
Action to Take -->
Tech stocks may not be timely, but theyoffer compelling values
and still stand to generate much improved results once IT budgets
loosen. Even if that doesn't happen until next year, these
bargains may not last that long. Remember, investors always look
ahead, and by the time investors get a sense that IT spending is
on the cusp of an upturn, these stocks will already have moved up
off of their lows.