Where to Find Value in the S&P 500
Why Mature Tech Is Still Sitting Pretty
After a heady run, U.S. equity markets may be getting cold feet. Global uncertainties, whether economic or political, have made the soaring prices of the past few years appear decidedly less probable in 2015. For investors seeking value, it’s cash on the barrelhead that will count. And when it comes to the sector with the most cash on hand, nothing compares to information technology.
A look at the ledgers bears this out: The tech sector holds more than half of the nation’s total corporate cash reserves, according to thedailyfinance.com. It boasts a cash-to-debt ratio of 106 percent, dwarfing health care (33 percent), industrials (22 percent), financials (19 percent), telecom (5 percent) – and every other sector in the S&P 500.
Much of this liquidity is concentrated in just four industry leaders and their bellwether tech stocks: Apple, Microsoft, Google and Cisco. Together, these mature tech firms – large, high quality brands – hold $345 billion in cash, or about 23 percent of total corporate cash reserves in the U.S.
Recent history shows that such strong balance sheets can act as a buffer when the markets turn sour. Last March, during a one-month selloff that saw the Nasdaq dip by 7.4 percent, momentum stocks like Amazon (-16.2 percent), Tesla Motors (-19.4 percent) and Netflix (-27.5 percent) took some of the most substantial hits. However, the old guard—at least by IT standards—not only weathered the storm but also added value, with Intel (+1.6 percent), Microsoft (+2.8 percent), Cisco (+2.9 percent) and IBM (+4 percent) all gaining ground.
The lessons of that spring swoon are still worth attending to a year later, as the S&P 500 has tripled since 2009. When it comes to finding opportunity in a sea of equities that seem fully—if not overly—valued, mature tech companies, with their consistent earnings and flush balance sheets, can serve as a beacon for value-driven investors.
Putting Cash to Good Use
Armed with well-capitalized balance sheets, many of the big tech companies are in prime position to deploy their resources in ways that could offer meaningful upside potential to investors. In an effort to unlock shareholder value, high-quality tech companies are increasingly using their piles of cash to increase dividends, repurchase shares and acquire other companies.
For example, on November 20, Intel announced a 6.7 percent increase to its annual dividend, a move intended to reflect “the board’s ongoing commitment to create value and return cash to Intel’s stockholders,” according to Chairman Andy Bryant. IBM made a similar move in April when it boosted its quarterly dividend by 16 percent (at a cost of $625 million
a year), topping Bloomberg projections by five cents per share. Just six months later, the tech giant added $5 billion to its stock buyback plan.
In mid-September, the Oracle board responded to an earnings miss by unveiling its own $13 billion repurchase program, and its stock has climbed more than 5 percent since. Not to be outdone, Microsoft bought back $2.89 billion of its own shares in the most recent quarter. But perhaps no company has been more active than Apple, which used its infamous $150 billion cash hoard to acquire growth in both the headphone and subscription music-streaming worlds when it purchased Beats Electronics for $3 billion in May, then expanded its capital return program—a mix of dividend increases and stock buybacks—from $100 to $130 billion.
In the case of Apple, billionaire investor Carl Icahn was an integral part in calling for a larger stock buyback, and many other tech companies are being pushed by activist investors to become more aggressive on such policies. But regardless of what inspires them, share buybacks by tech companies in the S&P 500 have already begun to accelerate: Between the second and third quarters of 2014 they increased by 40.4 percent.
Poised for Upside Potential
Having ample cash on hand has more fundamental advantages, of course. Given the sector’s enviable financial health, mature tech is also well positioned to not only benefit from growing capital expenditures as the U.S. economy accelerates, but also to help withstand an expected interest rate increase as the Fed tightens monetary policy.
Skeptics may point to tech stock valuations that currently sit just above their long-term average, but these numbers still look reasonable when compared to traditionally defensive sectors, such as utilities, which have surged in price and now appear vulnerable to rising rates. In contrast, the tech sector’s impressive performance over the past three years has been driven by earnings growth—not just multiple expansions—and that trend could easily continue in 2015.
One way to gain exposure to mature tech stocks is through the iShares U.S. Technology ETF (IYW) . which offers 99 percent exposure to information technology companies. This “pure-play” ETF concentrates on cash-rich companies like Apple, Google, Microsoft and Cisco, which make up nearly 42 percent of the portfolio 1. Additional tech heavyweights such as Intel, IBM, Oracle and Qualcomm are also represented in IYW’s top 10 holdings. A small allocation (about 17% currently) to established small- and mid-cap stocks, which may provide additional growth potential and diversification.
Bloomberg is not affiliated with BlackRock Investments, LLC. The Bloomberg article was sponsored by iShares.
*Source of information in this story is Bloomberg, as of 1/2015, unless otherwise noted.
1 As of 01/2015. Holdings subject to change.