The technology sector has performed better than the broad market recently, which is not saying all that much, but we put together a list of tech stocks that are worth taking a closer look. While some suggest that Tech will lead the market out of the bear market, we are not willing to speculate on that. What I do know is that some of the strongest balance sheets and best growth prospects are in the tech sector.
The premise of the Tech 10 is quite simple, using a simple stock screener (in this case Google finance) I separated out these companies largely based on balance sheet strength, and then I crossed the companies with the Ockham valuation framework. In this market many stocks look undervalued compared to historical multiples but only those with great balance sheets can give an appropriate risk/return profile.
Before we get to the list, here are the screens that I used to identify stocks with relative strength to the marketplace. First, we placed a floor on market cap of $1B, so that we only returned stocks with an established track record, no start-ups. Next, we looked at price-to-book value ratios. The low end of the range we set at .5 because if a stock is selling at less than half of book value there is a reason: either the assets are going to be written down or there are other underlying issues that warrant the especially low valuation below liquidation value. Likewise, we confined our search to companies with price-to-book of less than 5 for obvious reasons.
As everyone knows, and Sirius XM Radio (SIRI) has recently reminded us, stocks can fall into real trouble if there is a threat that the company will not be able to meet short term debt obligations, for this reason we have screened out any stock with a current ratio of less than 1. Also, we want to deal with companies that have minimal debt exposure even in the long term, so many of these stocks actually have zero long term debt but we have capped the debt-to-equity percentage at 3%. In an effort to takeout any companies that are no longer growing, we required a 5 year average revenue growth to be greater than 5%. And finally, we added a component to judge the management of these companies, as we only included stocks that have greater than 12% average ROE over the last 5 years. So, without further clarification, here are the results in order from largest to smallest:
1. Microsoft Corp. (MSFT)
Love them or hate them, they are the largest technology company in the U.S., and they have an exemplary balance sheet. Cash is king like never before, and Microsoft has gobs of it after being the operating system for more than a decade. There is now greater competition to the operating system business than there was during the antitrust days with Apple and Linux. And with the disaster that has been Vista, Microsoft is pushing as hard as they can to get Windows 7 on everyone’s desktop as soon as possible. While this company is mature and has far less growth potential than many others on this list (although they do pay a decent dividend), it is the balance sheet that you have to admire. They have cash of nearly $21 billion at the end of 2008, and have absolutely zero long term debt. At current valuations, there is a compelling argument for owning Microsoft.
2. Apple, Inc. (AAPL)
Long the thorn in Microsoft’s side, Apple has been creating the must-have devices one after another since the iPod was released in 2001. The company sells high end electronics and computers and has been grabbing market share for years. The string of hits products that has followed has given Apple the balance sheet strength to be the envy of any company. The company has continued to sell well even in this recessionary spending environment, which just continues the unbelievable growth that brings the 5 year average annual revenue growth to nearly 40%! For a company with a market cap of $80 billion, that growth is nothing short of spectacular. At the end of 2008, the company was sitting on a mountain of cash ($26 billion), as amazing $29 per share and no long term debt obligations. Even with the company’s iconic CEO Steve Jobs on hiatus, this company has plenty of options with that cash and lots of promise as the Apple faithful will remain loyal to their brand.
3. Qualcomm, Inc (QCOM)
Qualcomm makes the guts of cell phones and other wireless devices, and are pioneers in the 3G and upcoming 4G technologies. Smart phones are becoming the norm these days, as consumers want more out of their cell phones than just to make calls. Also, once users have become used to the mobile connectivity of one of these devices it is very tough to return to a simple phone. All phone manufactures are aware of it and have increasingly focused on smart phones in recent years, and Nokia (NOK) who used to compete with Qualcomm has just signed a joint venture with them is a recognition that QCOM has the edge in mobile technologies. As 3G infrastructure expands, Qualcomm’s licenses will become even more prevalent, and the company has room to grow into the next gen 4G networks as well. Once again, Qualcomm has no long term debt and a good amount of cash. Their current assets outweigh their current liabilities by an impressive more than 5 to 1.
4. Cannon, Inc (CAJ)
In comparison to the previous three companies mentioned, Cannon does not have the hoard of cash that the other do. However, the company still has a strong balance sheet with a very minimal amount of debt (just $8 million) and near term strength with a current ratio over 2. The Japanese printer and digital camera manufacturer again does not have the gaudy growth of Apple but has shown growth over the last five years. The company is trading at less than 9 times earnings, and perhaps most appealing; they are trading just 13% over book value.
5. Infosys Tech. (INFY)
Infosys is an Indian firm that provides IT- and end to end business solutions to help firms leverage technology more efficiently. As anyone who has called Technical Support in a while knows, much of the back office operations and call centers are moving to India. However, Infrosys is much more than call center coordinator; they are a prime beneficiary of the Indian outsourcing trend over the last decade. The company has grown revenue at a 41% annual rate over the last 5 years, and has zero long term debt and very little in the short term too. The company has achieved a very high ROE in the last five years as well, averaging 36% annually. Infosys’ greatest strength however could become its Achilles heel, as the company is extremely labor intensive. In 2007, the company received 1.3 million applications and hand selected the cream of the crop, just 3%. However, if India does begin to see rapid growth return than wage inflation will return along with it. At this point, Infosys has the margins to allow it to raise wages, but for how long and at what cost to the stock?
6. Applied Materials (AMAT)
Applied Materials is one of the more diverse technologies companies profiled in this list. They are in the semiconductor equipment business and the flat panel display business, and more recently have made a major splash in the solar energy space. Applied Materials become the first major company to supply power to their entire corporate headquarters by solar panels alone. In 2007, AMAT controlled 20% of the semiconductor industry and supplied to nearly every semiconductor factory in the world. There is major growth potential in both of AMAT’s major business lines, as the semiconductor equipment business continues to evolve as processors and chips become more complex and interest in alternative energy will inevitable fire back up when oil becomes expensive. The company’s debt is fairly small, and selling at less than two times book value is attractive, however the price to earnings of over 20 is a little bit concerning in this market.
7. Analog Devices (ADI)
Analog Devices makes analog, digital, and mixed signal processing integrated circuits, if that sounds like Greek to you, then join the club. Essentially, the company is creating receivers and processors that allow devices to transmit commands; one prime example is that this company supplied Nintendo with the system that allows the Wii to track position and acceleration. I will leave the specifics to the experts, but what I do know is that ADI has a strong balance sheet with no long term debt and a current ratio of 3.7. The growth has been a little slower than many of the others on the list, but with more technology using Wii-like sensors ADI has the expertise to pioneer this trend. The company did report earnings earlier this week and the company has hit a rough patch for sure with earnings coming in at half of estimates ($.08 vs $.16).
8. Maxim Integrated Products (MXIM)
Much like Analog Devices, Maxim manufacturers integrated circuits that are used in a broad range of products, including cars, consumer electronics, telecommunications, and medical devices. Also like ADI, the company is struggling with slumping sales right now, as the slowdown in the economy has hit cars, consumer electronics and medical devices very hard. However, even with the recent slowdown in sales the 5 year trend is still positive as revenue has grown annually by more than 12%. Also, much of the slumping sales figures have likely been baked into the prices as it currently sells at just 37% greater than book value per share. Because of a filing error the company was delisted from the NASDAQ, but that has since been corrected and the MXIM is back on the NASDAQ. There is some question as to how stable the dividend is with earnings hurting right now, but as of this moment the shares are yielding more than 6.5%. For a company with no debt concerns it could be an interesting addition to a portfolio.
9. Garmin Ltd. (GRMN)
Garmin is the market share leader in PND’s or personal navigation devices, and has a cell phone product in development as well. The stock is down nearly 90% from its highs a year and a half ago, as there are real concerns over competition from cell phones with GPS features already included. Furthermore, the marine navigation portion of the business has been crushed recently as well. However, with all of these concerns the company has a great balance sheet with no long term debt, three times more current assets than current liabilities, and currently selling at just 59% over book value per share. The concerns are surely warranted with the great amount of competition in the space, but revenue growth at 47% annually over the last five years should be at least intriguing, even if they cannot maintain that growth. At current price levels, the stock is trading at less than 4 times earnings and has a dividend yield of 5%. They will report fourth quarter results on Wednesday the 25th.
10. National Instruments Corp. (NATI)
National Instruments is a relatively small company that develops a range of products that provide ultra precise mechanical actions. Producing flexible application software, and modular, multi-function hardware that can be combined with computers, networks and third-party devices to create measurement, automation and embedded systems; again, this is a little bit over my head but they do many of the same things as competitor Aligent Tech. (A) What we do know is that this company meets the requirements of having a strong balance sheet and providing consistent revenue growth. This company has zero long term debt and current ratio is more than 4.3.
In conclusion, now more than ever is a time where “Cash is King”, and as the difficult operating economy continues, it will be the companies that are not overly leveraged that have the best chances for success. Furthermore, all of these companies, besides their robust balance sheets, all look undervalued compared to what the market has traditionally been willing to pay for a given level of cash flow and sales. The Ockham methodology compares these companies to themselves over the last ten years, so it is a way to gage how the market currently perceives each company. For investors, times like these require a good look at what a company actually has on its balance sheet, so please do your own homework before investing.