High Tech: Leader of the Pack

The Dow Jones Index (DJIA) moved into positive territory for the year on Friday, June 12 with the S&P 500 at 4.79% year-to-date (YTD). Although much has been written about the broader indexes bouncing off their lows and the state of the various industries being bailed out, it has been the tech sector that has been one of the leading industry groups this year from a stock performance perspective. The NASDAQ 17.87% YTD gains leaves the broader indexes in the dust.

There are several reasons for technology sector’s performance. First, tech companies are generally in better financial shape than many other industries. Many tech companies, especially those in business intelligence and data warehousing, have little, if any, debt and are therefore not directly impacted by the credit crunch (of course their customers are, so that impacts sales). Software companies are often cash-flow positive, even in lean times, with maintenance and service revenue offsetting slowing new license sales. The iShares S&P North American Technology-Software Index Fund is up 24.3% YTD, illustrating investors faith in software potential.

Second, many investors are thinking that the recession has …

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Second, many investors are thinking that the recession has bottomed and are anticipating a rebound in sales and profits at tech companies that may be stronger than in other industries such as consumer discretionary, financial services and real estate.

Business Intelligence (BI) & On-Demand Software Indexes

The Business Intelligence & Data Warehouse (BI/DW) Index and On-Demand or SaaS (software as a service) Software Index have posted 30% and 40% YTD gains, respectively, significantly outpacing the NASDAQ. The On-Demand Software index had been trailing the BI index but a 24% surge in the last month has it bolting ahead.

The BI index is made up of a mix of hardware and software companies with high tech titans intermixed with small cap stocks. It is an equal weight index so that the tech titans do not have any greater impact than their smaller brethren. The index is composed of companies that have been in existence for many years and have loyal groups of customers. Almost all are making a profit (20 out of 22) and the average P/E for those companies is 20.6. All of the BI stocks are positive YTD with the exception of the two analyst firms: Forrester (FORR) and Gartner (IT). The weakest of the high tech titans, from a stock perspective, has been Hewlett-Packard (HPQ) and that is primarily due to their exposure to the consumer market through both PCs and printer sales.

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The On-Demand Software index is composed of firms selling software-as-a-service (SaaS). With many of these firms are relatively new to the marketplace and are still in their build-out stage. Only 6 of 17 companies have achieved profitability and the firms making money sport an average 66 P/E. That’s nosebleed territory during a recession and “priced for perfection.” An acquisition premium is baked into many of these companies’ stock valuations.

These are stocks clearly enjoying momentum or speculation especially during their 24% run-up during the last month. It will take a while for these companies to grow into their current valuations, but of course, never underestimate an acquisition premium that another firm may pay for a “hot” technology.

What’s Next?

There are varying views on where the market will go: continue to move forward in a new Bull market spurred by an economic recovery; a re-test of the market lows because the recession is not over and people are getting in too early; or, neither as the market will bounce around range bound waiting for a sustained recovery.

Whichever direction the market goes, the BI index should continue to outperform the broader market while the On-Demand Software index is more likely to experience a more exacerbated journey.