Bloomberg News

Technology Stocks Cheapest Since 1998 Amid IPO Bubble Fear

June 06, 2011

(Updates with closing prices in eighth paragraph.)

June 6 (Bloomberg) -- The five-week drop in U.S. stocks has driven technology company valuations to the lowest level in more than a decade, making them too cheap to pass up for some of the nation’s biggest money managers.

The largest group in the benchmark gauge for American equities lost 7 percent through June 3, or about $190 billion in value, since the market peaked on Feb. 18, falling more than any industry outside financials. Computer stocks trade for 9.3 times reported earnings before interest, taxes, depreciation and amortization, 1.3 times the index’s multiple, data compiled by Bloomberg show as of June 3. The ratio is the smallest since at least 1998.

While signs of a slowing recovery and the initial public offering of LinkedIn Corp. have spurred concern the industry has entered a speculative bubble, the numbers show something different. Profits will rise 35 percent faster than the Standard & Poor’s 500 Index in 2011, and executives are boosting computer and software spending, data from Bank of America Corp. and Bloomberg show.

“We see the best supply-demand trend in technology,” said Michael Sansoterra, a money manager at RidgeWorth Capital Management in Atlanta, which oversees $48.5 billion including Broadcom Corp. and Google Inc. shares. “You can measure it pretty much every way you want and it looks attractive.”

Computer-Industry Earnings

Computer-industry earnings are almost double the level at the peak of the Internet bubble. Profits for technology makers in the S&P 500 totaled $135.6 billion last year, compared with $72.9 billion in 2000, when the S&P 500 Information Technology Index reached an all-time high, according to data compiled by Bloomberg. Bank of America says corporate expenditures on equipment and software will increase 10 percent this year, about four times faster than U.S. gross domestic product.

Per-share earnings at computer and software makers will climb 24 percent in 2011, outpacing the 17 percent increase for the S&P 500, according to projections from analysts surveyed by Bloomberg. Based on those estimates, technology companies trade for 12.8 times profit, compared with 13.1 for the S&P 500, data compiled by Bloomberg show.

U.S. stocks fell last week, the fifth straight decline, after the government said employers added 54,000 jobs in May, making it the worst report in eight months, and manufacturing trailed economists’ estimates. The S&P 500 slipped 2.3 percent to 1,300.16 as a group of computer and software makers including Redmond, Washington-based Microsoft Corp. and Hewlett-Packard Co. in Palo Alto, California, lost 1.9 percent, widening the decline since Feb. 17 to 7 percent.

The benchmark index for U.S. stocks retreated 1.1 percent to 1,286.17 at 4 p.m. in New York today, the lowest level since March 18.

Biggest Retreats

The retreat was exceeded only by financial companies, which has dropped 11 percent since Feb. 18. Technology stocks’ price- to-Ebitda ratio of 9.3 compares with an average of 14.5 times since 1992 and is 76 percent below the record 38.3 multiple reached on March 27, 2000, data compiled by Bloomberg show.

Economic growth slipped to a 1.8 percent annual rate in the first three months of this year from 3.1 percent in the fourth quarter, according to the U.S. Commerce Department. Technology shares rose 54 percent during the last nine months of 2009, trailing only financial stocks, as gross domestic product posted its biggest two-quarter expansion in six years.

LinkedIn Debut

LinkedIn in Mountain View, California, the first major U.S. social-media company to go public, surged 109 percent on its May 19 debut and traded as high as 31 times annual sales. The rally was a day before Harvard University Professor Lawrence Summers, the former U.S. Treasury secretary, said there’s concern technology stocks are in a bubble.

Groupon Inc., the largest provider of online coupons, filed with the U.S. Securities and Exchange Commission on June 2 to raise $750 million. The Chicago-based company discussed an IPO with underwriters in March that would have valued it at as much as $25 billion, or 9.7 times sales, people familiar with the matter said at the time.

The S&P 500 Information Technology Index trades for 2.4 times sales, data compiled by Bloomberg show. That compares with the average of 2.6 since 1992.

“I’m actually looking at this area, particularly with the selloff, to see if there might be some stocks that we can add,” said John Carey, a Boston-based money manager at Pioneer Investments, which oversees about $250 billion including Microsoft. “It’s out of favor. And yet technology is still a growing part of the world economy.”

Biggs Favorite

Hedge-fund managers have added computer stocks since Traxis Partners LP’s Barton Biggs said they were among his favorite investments at the start of 2010. Paulson & Co., the New York- based firm run by billionaire John Paulson, disclosed a $1 billion stake in Hewlett-Packard in a May 16 filing. David Einhorn’s Greenlight Capital Inc. told clients in April that it bought shares of Sunnyvale, California-based Yahoo! Inc.

Hewlett-Packard fell nine straight days through May 23, the longest streak since at least 1980, as the biggest personal- computer maker cut its full-year sales forecast. Yahoo dropped 6.5 percent in May as speculation grew it may benefit less from part ownership of China’s largest e-commerce provider amid tension with Alibaba Group Holding Ltd.

Greenlight also added 1.39 million shares of Microsoft last quarter, according to a filing with the SEC. The biggest software maker has slumped 14 percent this year after lagging behind the S&P 500 in four out of the previous five quarters. It trades at 9.7 times reported earnings, down from its peak multiple of 81 in 1999. The 34 percent discount to the S&P 500 is the widest since at least 1992, Bloomberg data show.

Microsoft Discount

Low valuations may not be enough to drive above-average gains. Since Oct. 9, 2002, the end of the bear market that followed the collapse of technology shares in 2000, Microsoft’s price-earnings ratio has averaged 18.6, compared with 23.9 for technology stocks in the S&P 500. Over the period, Microsoft has returned 53 percent including dividends, versus 131 percent for the industry, data compiled by Bloomberg show.

“The biggest statistical bargains tend to be the most controversial,” said Howard Ward, a money manager at Mario Gabelli’s Gamco Investors Inc., which oversees $35 billion in Rye, New York. “So far, momentum investors have not taken the bait. They are waiting for more evidence of a turn in the cycle. It will come, but timing the inflection point is murder.” His firm owns Mountain View, California-based Google and Qualcomm Inc. in San Diego.

Recovery Concern

Investors tend to move money from one sector to another in anticipation that some industries may profit more in a certain stage of an economic cycle. Technology companies trailed the market this year after posting the third-worst performance in 2010. The stocks have suffered in a rotation into companies whose earnings are least-tied to economic growth amid concern the U.S. recovery is slowing.

The shift has pushed the size of stock swings for computer and software makers to an almost-three-year peak. The S&P 500 Information Technology Index’s 90-day volatility relative to the S&P 500 rose to 1.23 on April 25, matching the level on April 14, 2010, which was the highest since July 29, 2008, less than two months before Lehman Brothers Holdings Inc.’s bankruptcy, Bloomberg data show.

Microsoft is worth owning because of the income it generates, said Channing Smith, a money manager at Capital Advisors in Tulsa, Oklahoma. The stock offers a dividend yield of 2.68 percent, compared with the S&P 500’s payout ratio of 1.92 percent, data compiled by Bloomberg show.

‘Income Play’

“It’s a very good income play,” said Smith, whose firm manages over $900 million. The company had $50.2 billion in cash and short-term investments on March 31, compared with $11.9 billion in long-term debt, according to a government filing. “Their balance sheet is unbelievable,” Smith said.

While the pace of hiring in the U.S. is slowing, American companies may spend more on automation to cut costs, said Smith of Capital Advisors. U.S. productivity, or employee output per hour, rose 3.9 percent last year, the most since 2002, according to Labor Department statistics released in March. Worker costs fell 1.5 percent following a 1.6 percent decrease in 2009, the first back-to-back drop since 1962 and 1963.

Corporate spending on equipment and software will increase 10 percent this year, compared with U.S. gross domestic product growth of 2.5 percent, according to Bank of America in Charlotte, North Carolina. Technology companies derive 60 percent of their sales from business spending, the highest portion among S&P 500 industries, the firm estimates.

“We are fans of the capital-goods sector,” said John Kattar, chief investment officer at Eastern Investment Advisors in Boston, which manages $1.7 billion. “Technology continues to get cheaper. It will outperform because of the recovery in capital spending.”

--With assistance from Nikolaj Gammeltoft and Joanna Ossinger in New York. Editors: Nick Baker, Michael Regan

To contact the reporters on this story: Lu Wang in New York at lwang8@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net


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