Tech Stocks For Lynch And Buffett
John Reese, Validea Hot List 07.10.07, 6:45 PM ET
In recent years, "tech" has been something of a dirty word when it comes to stocks, and, at least to some degree, with good reason. The market's nosedive during the first half of this decade was caused in large part by the widespread overvaluation of tech firms, as speculators searching for the next big thing bid up the stock prices of companies with little or no history of success.
Since then, many have been hesitant to jump back into technology, not wanting to get burned again.
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But tech stocks are making a comeback. I recently read in USA Today that 18.3% of initial public offerings during the first half of 2007 involved tech companies, up from 14.7% in the first six months of 2006. The $26 billion raised by tech IPOs ranked second only to health care in terms of sectors going public.
One indication that the tech market has stabilized can be found by looking at the CBOE Nasdaq Volatility Index. Five years ago, the tech-heavy options premium index was pushing 60; today, it stands around 17, not much higher than the S&P 500 (about 15.3) or S&P 100 (about 14.5) volatility indexes.
What I found was that my Buffett and Lynch models are indeed interested in the technology sector, though some of their favorites are not your typical, computer-related tech firms. Nonetheless, technology is a major part of what these companies do, and despite their lack of flash or glitz--or perhaps because of it--they've performed quite well lately.
Genlyte Group: This Kentucky-based mid-cap ($2.3 billion) is the world's largest company dedicated exclusively to the design, manufacture and marketing of lighting fixtures, control systems and other products for commercial, industrial, and residential home buyers. Genlyte has 45 different brands of lighting products, and has an aggressive expansion plan in place. The firm introduced more than 20,000 products and 380 product families last year, and has an ongoing goal of generating 30% of revenues from products introduced within the past three years.
Never one for speculation, Buffett invests in companies that have a long history of strong, stable earnings, and Genlyte fits the bill. The firm's earnings per share have increased every year for the past decade, with its EPS rising from $0.71 to $5.37 in that time. That's the kind of consistent earnings growth that my Buffett-based strategy likes to see.
Buffett-type stocks also are those that are conservatively financed, so my Buffett-based strategy requires that a company could, based on its earnings, pay off its long-term debt within two years. Genlyte currently has $62.5 million in debt and earnings of $141.5 million, meaning it could use those earnings to pay off its debt in less than a year. My Buffett model considers that exceptional.
Genlyte also gets approval from my Lynch-based strategy, which considers the company a "fast-grower"--Lynch's favorite type of investment--because of its 38.25 growth rate (based on the average of the three-, four- and five-year earnings per share figures).
To find growth stocks still selling at a good price, Lynch famously uses the price-to-earnings-growth ratio, which divides a stock's price-to-earnings ratio by its historic growth rate. P/E/G ratios lower than 1 are acceptable and indicate that the stock is still a good buy at its current price; P/E/Gs under 0.5 are the best cases.
When we divide Genlyte's 16.99 P/E ratio by that 38.25% growth rate, we get a P/E/G ratio of 0.44, which falls into the best-case category. (I would note that that 38.25% growth rate will be difficult to maintain in the long-term, but even if the company posts growth numbers half that size in the future, it will be well off.)
In addition, my Lynch-based model also likes Genlyte because of its manageable debt. The firm's 21.37% debt/equity ratio easily beats the 80% maximum used in this strategy.
Eaton Corporation: Based in Cleveland, Eaton makes a wide array of industrial products, ranging from photoelectric and proximity sensors to power-distribution systems to high-performance golf club grips. Many of its products are used in automobiles or airplanes. Its intelligent drive-train systems, which aid in safety and fuel economy, are used in trucks, and the company also produces components that are used to guide commercial aircraft.
My Lynch-based strategy is high on Eaton, which it considers to be another fast-grower. The firm's P/E ratio (15.29) and growth rate (34%, based on the average of the three-, four- and five-year EPS figures) make for a 0.45 P/E/G ratio. That's more than acceptable, falling into the best-case category of my Lynch model's most important test and indicating that this fast-grower is still selling at a good price.
Eaton, which has a $14.2 billion market cap, doesn't have as attractive a debt/equity ratio as some of the other stocks I'll mention. But at 76.9%, it still comes in under my Lynch-based model's 80% maximum.
Rockwell is another fast-grower that gets the nod from my Lynch-based strategy. The company has a P/E ratio of 22 and a growth rate of 34.09% (again, based on the average of the three-, four- and five-year EPS figures). That makes for a 0.65 P/E/G ratio, which passes my Lynch model's test and indicates the stock is still a good buy.
In addition, Rockwell has manageable debt, with a 34.7% debt-to-equity ratio.
One more reason my Lynch-based model likes Rockwell: Its inventory/sales ratio decreased from 11.39 % to 10.78 % this year. Having merchandise pile up is never a good sign, and my Lynch model sees it as a red flag when inventory increases faster than sales. Rockwell's sales are increasing faster than inventory is piling up, however, passing this test.
SAP AG: While my guru models are high on several technology-based companies that aren't what you might consider typical tech firms, there are also some more traditional, computer-related tech stocks that appear to have staying power.
The German firm SAP , for example, gets high marks from both my Buffett- and Lynch-based strategies. This large-cap ($61.1 billion) is the world's largest business software company. It makes a variety of software solutions for companies in a wide range of industries, as well as for government agencies and educational institutions. SAP has more than 38,000 customers worldwide, and has employees in over 50 countries.
My Buffett model likes SAP because its EPS have dipped just twice in the past decade, with the last dip coming five years ago. SAP's EPS have increased from $0.48 to $2.05 over the past 10 years, showing enough earnings predictability to pass a key Buffett-based test.
Another reason that both my Buffett and Lynch models are extremely high on SAP: The company has no long-term debt.
In addition, my Lynch-based model likes SAP because the company's P/E ratio (24.17) and growth rate (28.98%, based on the average of the three-, four- and five-year EPS figures) make for a 0.83 P/E/G ratio. That comes in under this model's 1 maximum, indicating that, while SAP has been growing quickly, the stock's shares are still selling at a good price.
Logitech: Logitech is another computer-related tech company that gets high marks from my Lynch-based model. The Swiss firm creates an array of computer peripherals, including mice, keyboards, webcams, speakers and videogame controllers. The company, whose Americas headquarters is located in California, has strategic partnerships with most top PC makers, and its products are distributed in more than 100 countries around the world. It has a market cap of $5 billion.
One big reason my Lynch model likes Logitech: With a P/E ratio of 22.83 and a growth rate of 24.06% (based on the average of the three-, four- and five-year EPS figures), the company sports a 0.95 P/E/G ratio. That's good enough to pass my critical Lynch-based P/E/G test, and indicates that the fast-grower is still a good buy at its current price.
My Lynch-based model also likes Logitech because of the firm's conservative financing--its debt/equity ratio is a mere 1.4%.
Between the rapidly changing nature of technology and the speculation that tech stocks engender, the tech sector can be a dangerous place for investors. Many are continually looking to get in early on the creator of the next hot product that will fly off the shelves or become an indispensable part of consumers' lives, and more often than not, these speculators fail.
These companies demonstrate that high-tech doesn't have to mean high-risk. All of these firms have posted several years of strong, increasing earnings and have manageable debt. If you're looking to get in early on the next Microsoft or eBay, you probably won't find them here. But if you're looking for proven tech winners that appear poised to generate more strong returns, these stocks are a great place to start.
John P. Reese is founder and CEO of Validea.com and Validea Capital Management. He is also co-author of The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best. Click here for more of Reese's insights and analysis, and to learn about subscribing to the Validea Hot List. At the time of publication, John Reese and his clients were long Genlyte Group, SAP and Rockwell Automation.
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