What are we looking for?
Strength from the information technology sector.
The screen
Equity markets have been grinding higher, underpinned in general by fundamentally strong earnings and improving economics.
Over the past year, the S&P 500 total return index has gained 18 per cent, for example. The IT sector has been the largest contributor – the S&P 500 IT total return index has risen 20 per cent year-to-date and 35 per cent over the past 12 months. Valuations in the sector have also been rising with the rest of the market. Currently, the IT sector trades at an average of 18 times expected earnings compared with 16 times expected earnings at the same time last year. Expectations are still high for the industry, however, and there could still be room for growth as long as execution remains strong.
In order to identify a selection of potentially undervalued but expanding IT companies, my colleague Lawrence Ullman and I used Bloomberg to find the top 15 U.S. IT companies above $500-million (U.S.) in market cap with the best mix of:
- Sustainable growth rate (the rate that a company can grow without seeking outside financing to fund that growth);
- Operating margin (operating income as a percentage of total revenue);
- EV/sales (total enterprise value to sales, a lower figure is better);
- Forward price-to-earnings;
- Cash flow-to-debt;
- Consensus earnings-per-share estimate revision over the past three months.
More about the Ullman Group
The Ullman Group is a provider of strategic private capital management services to high net worth individuals, corporations, endowments, charities and foundations. Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.
What we found
Using Bloomberg, we performed a back-test starting May 31, 2007, selecting an equally weighted portfolio of the best 15 companies. The portfolio was reselected and rebalanced quarterly. Over the entire period, this strategy would have generated an annualized total return, in U.S. dollars, of 12.4 per cent compared with 7.2 per cent for the S&P 500 total return index and 11 per cent for the S&P 500 IT total return index.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.
Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.
Richardson GMP Ltd. is a member of the Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities LP. Both are used under licence by Richardson GMP Ltd.