It has been a long time coming, but it appears that bottom-up forward-earnings expectations for the information technology (IT) sector appear to be rising again after a two-year funk. In addition, the consensus calendar-year expectations for the sector are increasing for the first time since 2011.
There are a number of possible explanations for this. Perhaps improvements in the American economy that were evidenced in last week’s jobs numbers are encouraging corporations to accelerate their technology upgrade programs, or perhaps American consumers feel the same impetus to buy some of the cool new products or services that some of the high price/earnings multiple, cutting-edge IT companies produce. Maybe the worst effects of the European recession are slipping into the past, and the IT companies doing business there have adjusted to the environment.
For whatever reason, the lines on the chart below seem to be telling a story of improvement, a story that seems to say that the IT earnings recovery that ended in 2012, at last, has been succeeded by what could be the beginning of earnings expansion. I think that that is important news that could spur the sector to outperformance.
Past performance is no guarantee of future results.
The IT sector is a big place with a lot of different companies doing different things in different ways. However, I think the sector could properly be divided into two general areas: new technology and old technology, or, as I prefer to call them, high tech and industrial tech. We like both and, accordingly, are overweight both. The reasons and the timing differ, however.
We have liked industrial technology for some time. We saw (and still see) very good value here. To us, the story has been that of companies selling technology to other companies and, in the process, making those other companies more efficient and much more profitable. To us, this phenomenon was squarely behind the corporate earnings bloom of the past several years. It is a story that I think is far from finished.
More recently, we have emphasized the high-tech side of the story. This is unusual for us because I believe that these types of stocks are in the domain of portfolio managers, not portfolio strategists. Each company has a story that is as unique as the hardware, software, or service it offers. It is a classic case for bottom-up analysis. However, after the recent de-risking of the market and consequent sell-off in high-multiple stocks, I thought that we had something to say. The sell-off appeared to be the result of a valuation reduction, not a wholesale change in the fundamentals of the companies. In my experience, such valuation compressions have been ephemeral. If the growth remains intact, they have been a bit like falling uphill. They have been opportunities to buy, not reasons to sell. We believe that that is probably the case today. If anything, the chart above seems to justify that thought.