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number cruncher

Ian Tam, CFA, is director of investment research for Morningstar Canada.

What are we Looking for:

U.S. tech stocks trading below fair value.

The screen

With the Nasdaq hitting record highs, technology stocks have been on a rampage, magnified by the market volatility of the pandemic. As a sector with traditionally strong growth, it’s often difficult to find a fairly valued company – an important characteristic for conservative and value-oriented investors alike. To this end, this week I use Morningstar CPMS to find ideas among the 296 U.S.-listed tech companies by ranking them on (1) the average return on equity (a profitability metric) over the past three years, and (2) the standard deviation of return on equity over the same period. Recall that standard deviation is a measure of volatility. Today, we seek companies with lower (or more consistent) standard deviations.

Additionally, I screened for stocks that are trading below fair value, according to Morningstar’s analysts. (Morningstar’s fair value estimates are rooted in our analysis of a company’s competitive barriers to entry as well as a traditional discounted cash flow model.) To do this, I leverage Morningstar’s Star Rating for stocks. Recall that a stock with one star is considered grossly overvalued while a stock with five stars is trading well below fair value. Today’s model looks for companies that have been rated four stars or better.

What we found

I used Morningstar CPMS to back-test this strategy from April, 2004, to June, 2020, using a maximum of 10 stocks. Once a month stocks were sold if their ranking dropped into the bottom half, or if the star rating dropped below three stars (signalling that the stock is trading above fair value). Over this period the strategy produced an annualized total return of 14.5 per cent while the Morningstar US Technology TR Index produced 13.2 per cent. The six stocks that meet the requirements today are listed in the table.

This article does not constitute financial advice. It is always recommended to speak with an adviser or financial professional before buying or selling any of the securities listed here.

Six U.S. tech stocks trading below fair value

RankCompanySymbolMorningstar IndustryMorningstar Star RatingMarket Cap (USD, Millions)3Y Average ROE (%)3Y Deviation of ROE (%)Dividend Yield (%)Recent Close (USD/Share)Total Return from Month End, 12M Ago (%)
1F5 Networks IncFFIV-QSoftware—Infrastructure4 Stars8504.937.13.10.0139.058.0
2Intel Corp.INTC-QSemiconductors4 Stars205419.926.83.72.748.33.9
3Sensata TechnologiesST-NScientific & Technical Instruments4 Stars6081.023.82.70.038.68-15.1
4Arrow Electronics IncARW-NElectronics & Computer Distribution4 Stars5631.013.71.30.072.544.8
5Xerox Holdings Corp.XRX-NInformation Technology Services4 Stars3410.416.51.86.216.01-41.3
6Sabre Corp.SABR-QInformation Technology Services5 Stars2103.639.912.60.07.635-65.9

Source: Morningstar Canada

More about Morningstar

Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals.

Morningstar Canada on Twitter: @MorningstarCDN.

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