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Earnings slowdown not a problem for tech stocks Add to ...

There are two main arguments against owning large-cap technology stocks right now: Most of the sector’s good news revolves around Apple Inc. and the big gains are over now that the Nasdaq composite index has risen more than 15 per cent this year, to its highest level since 2001. However, Savita Subramanian, equity and quant strategist at Bank of America, believes that there are still compelling reasons to overweight tech stocks.

Relatively low valuations is one of the biggest reasons. As Ms. Subramanian noted, the sector trades at 12.8-times estimated 2012 earnings, which is 30 per cent below its historical average, after ignoring the bubble years of 1998 to 2001. What’s more, tech’s historical valuation premium over the rest of the market, averaging 24 per cent, has disappeared.

“Tech earnings expectations could fall by as much as 30 per cent and the sector would still trade at a discount to history, even excluding the tech bubble,” she said in a note. “Tech is one of only three sectors trading below both the absolute historical average multiples and historical relative multiples (energy and health care are the other two).”

Meanwhile, Ms. Subramanian acknowledged that earnings growth driven by the economic rebound is slowing down sharply. She estimates that earnings growth for the entire S&P 500 will slow to just 6 per cent to 7 per cent in 2012, down from double-digit growth earlier.

But this shift to secular growth is not necessarily a problem. She argued that stocks with strong growth prospects have consistently outperformed mere economically sensitive stocks during profit slowdowns. Tech stocks might be ideally suited here: Other than health care stocks, tech was the only sector able to grow its earnings through every year of the last recession.

“Many of the secular growth stories today are directly or indirectly related to tech, so in our view the sector is the best way to gain broad exposure to secular growth,” she said.

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  • Updated May 26 4:00 PM EDT. Delayed by at least 15 minutes.


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