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Computerized Investing > Third Quarter 2013

Tech Valuations Belie Market Heights

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by Wayne A. Thorp, CFA

Much has been made in the popular press recently of the S&P 500 index hitting an all-time high, at least on a nominal basis. This run-up has some investors and analysts fretting that the market is becoming overvalued and, thus, poised for a pullback. When looking at technology stocks, however, the story is very different. According to a recent InvestmentNews article, tech stocks are trading at their lowest valuations since 2006, and potentially could fall even farther as consumers and government agencies alike cut spending. Technology bellwethers such as Apple Inc. (AAPL), Microsoft Corp. (MSFT) and Intel Corp. (INTC) all have forward price-earnings ratios that are at least 25% below their seven-year historical averages (according to data in AAII’s Stock Investor Pro fundamental stock screening and research database as of May 31, 2013).

If you are a contrarian investor, these low valuations offer an attractive buying opportunity, especially considering that technology issues tend to lead the way during periods of economic expansion. If you have been paying attention to recent economic news, it appears that the U.S. economy has turned a corner. So, if you believe valuations eventually revert back to the mean, these low historical valuations offer tremendous upside potential.

Bears, on the other hand, point out that the slide in valuations may not be over. This is due to the fact that a global economic recovery is not a foregone conclusion, as evidenced by soft economic data coming out of Europe and China. In addition, government IT spending is set to decline, adding downward pressure on tech sales and, ultimately, earnings. According to Bloomberg, second-quarter earnings at computer firms are expected to decline nearly 6%.

Compared to the tech boom of the 1990s, tech companies are definitely reasonably priced. The question is whether these valuations will become even more attractive in coming quarters or a stabilizing global economy will spur spending, and earnings, thereby powering valuations upward.

For mutual fund investors, this issue offers a treasure trove of information. In the Comparison, Joe Lan reviews the top mutual fund screening and analysis services and their relevant features. Then, in the Feature, Joe uses these same services as the cornerstone in the first of a series of articles that explores mutual fund screening and analysis. In part one of the series, Joe begins by covering the basics of mutual fund screening and the issues to consider when trying to identify potential mutual fund candidates.

Followers of AAII’s stock screens should take a look at this issue’s Spreadsheet Corner, where I look at the downside risk of each of the methodologies using the Ulcer Index, which is also highlighted in the Technically Speaking column. The Ulcer Index is useful in that it measures the breadth and duration of an investment’s or portfolio’s drawdown (while ignoring upside volatility) and allows investors to compare the relative risk of different investment strategies.


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