Yahoo Finance The Pros of Investing in the Technology Sector
Technology has been the clear standout sector within the Standard & Poor's 500 index. The sector returned 12.4 percent for the third quarter and some of the largest names -- like Apple (ticker: AAPL), Microsoft Corp. ( MSFT), Intel Corp. ( INTC), Cisco Systems ( CSCO) and Facebook ( FB) -- reported positive second-quarter earnings results.
There is reason to believe that positive results will continue.
August data published by the Bureau of Economic Analysis shows record high consumer spending in technology-related categories -- at 4.1 percent year-over-year growth, this is the fastest growth since the first quarter of 2010. A standout has been computer spending growth -- the 7.4 percent year-over-year growth in personal computers and peripheral equipment is the best growth since fourth quarter of 2011 and represents 26 percent of total consumer technology spending. Consumer spending on software also accounted for 23 percent and grew 2.5 percent year-over-year.
Broadly speaking, technology remains attractive with its strong cash position and lack of sensitivity to rising oil prices and interest rates. In fact, rising interest rates could increase interest earnings for cash-rich companies, such as Apple. Over the next three to five years, global consumers will likely adopt faster 5G wireless technologies and significantly faster wireline technology, such as optical fiber to the home.
[See: 9 Blue-Chip Powerhouse ETFs to Buy.]
Millennials will make an impact, too. Many couples in this demographic will purchase single-family homes, like previous generations before them, and purchase their first TV or upgrade their current TV to a larger 4K screen. Furthermore, newly constructed homes will likely be equipped with the latest internet of things technology to monitor appliances, activate a home security system and to minimize energy consumption.
Likely beneficiaries of these trends include semiconductor company Broadcom Limited ( AVGO) and technology retailer Best Buy Co. ( BBY).
Following the combination of Avago and Broadcom, the new Broadcom is levered to growth in the areas of advanced wireless technologies, smartphones, data center spending, IP traffic and the internet of things. These areas are expected to grow at strong double-digit compounded annual growth rates over the next several years.
As the uses of wireless technologies continue to multiply, Broadcom's sophisticated FBAR (Film Bulk Acoustic Resonator) filters ensure wireless devices capture the right signal for the right device. Consumers and corporations are upgrading to faster and more data intensive computer hardware, and this new hardware will be embedded with the latest communication semiconductor chips from suppliers like Broadcom. It is also important to note that Apple represents 20 percent of Broadcom's revenue, and competitors, such as Qualcomm ( QCOM), Skyworks Solutions ( SWKS) and Qorvo ( QRVO) aggressively vie for this business.
[Read: 4 Technology Stocks to Charge Up Your Portfolio.]
Post-merger, Broadcom carries $15 billion of debt versus $2 billion of cash. However, this debt load is manageable given the company is expected to generate almost $5 billion of free cash flow in 2017, of which only $900 million will be used to fund the dividend. At 12.5 times estimated calendar year 2017 earnings, Broadcom offers an attractive valuation: a 1.1 percent dividend yield and an estimated long-term earnings growth rate of 15 percent.
As for how technology-related devices are purchased, given the rapid growth of online retailers, many investors have written off traditional brick-and-mortar retailers. However, Best Buy trades at 12 times estimated calendar year 2017 earnings versus 78 times for online retailer Amazon.com ( AMZN). Investors are ignoring several important trends, as domestic sales have turned the corner and have grown for the last several quarters.
Best Buy's domestic online portion grew 24 percent last quarter and now represents 10.6 percent of U.S. sales. Expenses are expected to grow at a slower rate as the company transitions to more online sales. This offers the potential for margin expansion over time. Since faster data speeds enable higher quality video, consumers are more likely to visit showrooms and consult with employees as to which TV stand or audio technology will complement their home theater experience. Some customers may also hire Best Buy to install sophisticated technology or purchase an extended warranty.
Best Buy is estimated to generate $1 billion of free cash flow next year. An estimated $500 million will be returned to shareholders in the form of a dividend and $300 million will used to repurchase stock. Best Buy currently yields 2.8 percent and long-term earnings are estimated to grow 11 percent per year. In the past 10 years, the company has repurchased 33 percent of its shares outstanding.
Technology has impacted much of the world, and the financial industry is no different -- companies in this sector are seeing the effects firsthand, as investors look to find profit.
[See: 8 Tech Funds to Buy to Invest in the Future.]
Disclosure: Leslie Thompson and clients of Spectrum Management Group own AVGO, BBY, AAPL, MSFT, CSCO and FB.
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