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.
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