What are we looking for?
Once again, the U.S. information technology sector is outpacing the broader market. As of Feb. 21, the sector was up 10.7 per cent while the S&P 500 was up 4.4 per cent since the start of the year. The IT sector is well known for its high growth companies with high multiples, while the value ones are often forgotten.
Today, we will be looking for value U.S. large caps in the IT sector with the focus on companies that have been beaten down by the market over the past year. Such stocks often offer great value, but sometimes the lower valuation is justified, so we need to be mindful of this caveat.
The screen
We screened the U.S. companies from the IT sector by focusing on the following criteria:
- A market capitalization greater than US$10-billion;
- A share price 10 per cent to 50 per cent below its 12-month high – this is our filter to find beaten-down companies;
- A price-earnings ratio between 0 and 27.5 – we want a company with positive earnings and one that is not too expensive;
- Return on capital higher than 10 per cent – we want to find profitable companies that have good return on investment;
- A free-cash-flow-to-capital ratio that is greater than zero – we want a company that generates positive free cash flow.
For informational purposes, we have also included recent stock price, dividend yield, one-year price return and 24-month change in sales. Please note that some ratios may be as of the end of the previous quarter.
More about Inovestor
Inovestor for Advisors is a fundamental-analysis research platform specializing in the economic value-added approach. With Inovestor, advisers can quickly identify attractive investment opportunities, outsource their stock picking by using model portfolios, and easily communicate investment decisions with clients through client-friendly reports. In addition, Inovestor allows users to create personalized filters, build custom portfolios and carry out in-depth analysis on more than 13,000 companies (Canadian stocks, U.S. stocks and American depositary receipts).
What we found
First, we compute the inverse of the price earnings ratio, also known as the earnings yield. Then, we calculated the average of each of the following: earnings yield, free cash flow to capital, return on capital, and the 24-month sales growth for each company. Taken together, these calculations allow us to distinguish cheap companies with good fundamentals from those with bad ones. They are ranked accordingly, by a filter selection score.
Based on our selection filter, Seagate Technology PLC and NetApp Inc. have the worst results as their fundamentals seem to support the low valuation. Arista Networks Inc. has the highest score of the list. The company offers a decent price earnings of 20.3 for a great return on capital of 26 per cent, a FCF-to-capital ratio of 28.1 per cent and two-year sales growth of 46.4 per cent. On Feb. 13, Arista reported a decline of 7.2 per cent in fourth-quarter sales compared with the same quarter in 2018, but full-year sales increased by 12.1 per cent.
Investors are advised to do further research before investing in any of the companies listed in the accompanying table.
For more details about Arista Networks stock and performance, please subscribe the Inovestor for Advisors platform for free.
Christian Godin is a portfolio manager at Inovestor Asset Management.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.