Yesterday's tech for today
The S&P 500 has more than tripled in value since 2009, leading many to declare that U.S. stocks are fully valued. However, opportunity may still exist in at least one sector – technology. While global growth worries threaten to end the bull market cycle, tech stocks, particularly those of mature tech companies, may offer upside potential in the near-term for the following reasons:
1. Well positioned for upcoming rate and capex cycles
With the U.S. economy continuing to show signs of improvement, the Fed is expected to raise rates in the near-term.
- Increasing borrowing costs should have less of an effect on tech as it is the only sector with positive net cash (Figure 1).
- Tech has historically performed well during periods of rising rates, particularly compared to sectors with more debt.1
- As a pro-cyclical growth sector, tech can potentially benefit from continued economic improvement and an expected increase in capital spending by U.S. companies across the board.
Figure 1: Net debt per share for S&P 500 sectors
2. Strong balance sheets
Thanks to their enviable financial health, certain tech companies may likely deliver shareholder returns over the coming year through share repurchases, dividend increases and M&A activity.
- High-quality, mature tech companies may be more inclined to take these actions and, in some cases, are being pushed to do so by activist investors.
- The tech sector claims 40% of total corporate cash reserves in the U.S., and is responsible for 56% of the increase in total corporate cash over the last five years.2
- Tech spending on buybacks and dividends (as a percentage of free cash flow) is 22% above historical levels.3
3. Reasonably valued with upside potential
Tech stock valuations look reasonable compared to other U.S. sectors and there may be additional room to run.
- Tech sector earnings have grown in each of the past five years, with earnings expected to continue expanding in 2016 and 2017.4
- Tech companies currently trade in line with the S&P 500, and well below their trailing 10-year average of 9% P/E premium.5