In past articles on Gurufocus, I have taken you through a collection of modern-day tech gamut, ranging from smartphones to processors to tech concepts like 4G, Cloud and Big Data. Now let me take you through the investment part of this tech gamut. After cruising through the past articles, the obvious question that will pop up is: What am I earning out of it apart from the insight?
Keeping that in mind, this is my endeavor towards creating an earnings pool for individual investors and analysts. Technology stands to benefit from an improving macroeconomic environment around the globe, new and promising business opportunities like âBig Dataâ and âCloud Computingâ solutions. Moreover, underlying company valuations stand at attractive levels, particularly given the current growth prospects. The other major driver is that enterprises across the globe are restructuring to increase their cost-to-output ratio.
Before getting into the nitty-gritties of the investment thesis, I would like to set the backdrop of this discussion clear that while there are different combinations and funds that might be useful to investors, we tend to favor a broad approach to this information technology (IT, Financial) opportunity using a large and very liquid ETF such as the Technology Select Sector SPDR Fund (XLK/A-78).
Increasing IT focus
According to PricewaterhouseCoopers' (PWC, Financial) July 2014 manufacturing index, 33% of industrial manufacturers plan to increase spending on information technology over the next year, up from 28% in the similar period last year. To add to this, research reports by Gartner (IT, Financial) illustrates that global spending on enterprise software is expected to rise more than 6% this year, while spending on IT services as a whole are likely to grow at the rate of 4%.
The semiconductor industry has already waved the checkered flag signaling the start of growing demands. The evidence of this growth in demand can be established from the improving book-to-bill ratio of the chip manufacturing companiesâ financial reports and books, which measures orders received relative to units shipped and billed. Specifically, the global semiconductor equipment manufacturing book-to-bill ratio is currentlyĂ standing at 1:17 which is at its highest level in recent years, a 19% jump from its level just a year ago.
The increased demands are also boosting utilization rates in semiconductor fabrication plants, thus adding flying colors to their gross margins. DRAM and flash memory chips are posting the best growth numbers in the industry, 33% and 22% respectively, in the last quarter. When we talk about IT industry and semiconductor sector growth, one segment that misses out from our mind is the automobile sector. With cars becoming technically advanced and more and more dependent on chipsets and sensors to give enhanced driving and safety features, they are also commanding a large chunk of orders for the semiconductor segment. Digital chipset and DRAM demand from the auto sector has grown more than 30% in the last quarter.
After analyzing this trend shift, it is quite obvious that Intel (INTC, Financial), Seagate (STX, Financial) and Qualcomm (QCOM, Financial) have projected that the second-half earnings-per-share growth will be driven by PCs, storage drives, and phones.
Big Data getting bigger
Another revolution driver is the advent of Big Data -- an IT-world brain child which has been growing in leaps and bounds. Companies are ramping up their corporate architecture to keep pace with the latest in IT and reap the benefits of Big Data.
In 2014, $15 billion is expected to be spent on big data technology compared with less than $10 billion two years ago. Spending growth in the big data space is expected to be 27% annually over the next five years, compared to 4.5% growth for overall IT spending, which means a major portion of the total IT spending would be towards Big Data. New software tools, like Microsoft's (MSFT, Financial) Azure Intelligent Systems, are helping to bolster this growth by streamlining data analysis processes.
The clout of Cloud computing
Another recent IT innovation that has raised a storm of revolution and has added a new dimension to the IT business is the âCloud Computingâ. Software delivery using the âCloudâ is also picking up pace and is one of the key segments of software spending. Global cloud software revenue is expected to grow 25% to $35 billion in 2014, and is projected to grow further ahead at the rate of 22% annually through 2017, as projected by IDCĂ data.
âSoftware-as-a-serviceâ applications are the key sector of the cloud software market, and technology firms are adapting their business models to these new methods. SAP (SAP, Financial), Oracle (ORCL, Financial) and other large enterprise software vendors are moving from a license-based to a cloud-based subscription model with the focus of increasing the percentage of recurring revenue earnings. This helped to grow SAP's cloud subscription revenue to more than double in fiscal 2013, and now this segment accounts for more than $1 billion in revenue.
The âPlatform-as-a-Serviceâ attribute of the cloud is another way companies are tapping it as a revenue earner. Recently, some of the largest technology firms across the globe like Microsoft, Oracle, and Salesforce(CRM, Financial), have created cloud platforms that combine database, middleware and application-deployment tools as a service on the cloud.
The âPlatform-as-a-Serviceâ arena is expected to grow 30% annually over the next five years, and cloud-based software delivery should be doubling in the next three years.
PC âI am Backâ
Microsoft announced its decision to end support for its Windows XP operating system which has already initiated a worldwide upgrade cycle in both the corporate and consumer segments. In what may be a turning point for the PC industry, worldwide PC demand and supply experienced a flat growth through the second quarter of 2014, going by the latest figures from Gartner, after eight consecutive quarters of decline. In the U.S., PC shipments totaled 15.9 million units in the second quarter of 2014, a 7.4% annual increase, owing to Dell's (DELL, Financial) second consecutive quarter of double-digit growth and HP's (HPQ) fastest increase of demand since 2010.
Also worth noting, Apple (AAPL) reported Mac personal computer sales were up by 18%, while that of iPad tablets declined 9% in the last quarter. This regained stability in the PC market, coupled with the slowdown in premium tablet sales, is expected to continue as PC sales are now growing off a smaller base of users for both desktops and notebooks.
IT sector valuation looks lucrative
Looking at the IT sector from a valuation perspective, the Russell 3000 Technology Index is trading at a price-to-earnings multiple in line with the S&P 500 Index. That's the current picture, even though the long-term growth projections for the technology sector stands at 11% which scales ahead of the 8.6% long-term growth projection of the S&P 500.
As I had mentioned in the start, we would use XLK to deduce all that we perceive of in the IT sector activity. It has almost tanked in $14 billion in assets, which makes it relatively easy to trade.
Whatever the preferred vehicle is, the takeaway is that we believe technology deserves a premium consideration in excess of the market, given the strong growth prospects and well-defined dimensions driving the growth in the near to long-term time frame.
