Why the Rally in the Tech Sector Has Legs
Why 2015 Does Not Look Like Y2K (Part 4 of 4)
3. The sector has potential for continued growth.
Mature, established tech companies have strong balance sheets and large cash accounts that they’re putting to work for shareholders via buybacks and dividends. In addition, technology stocks also may benefit from increased capital expenditures outside the tech sector aimed at boosting productivity and sales.
To be sure, this isn’t to say that there aren’t pockets of froth in the U.S. technology space, particularly in social media. So, while I continue to favor the technology sector, I advocate focusing on the mature tech companies with real earnings.
Market Realist –
The rally in the tech sector has legs given the amount of cash and the current level of debt.
The graph above compares the cash and equivalents for top tech companies. The amount of cash with mature tech companies is mind-boggling.
Apple (AAPL) has by far the most cash in the industry, with $193 billion. This is enough to distribute $600 to every American. Microsoft (MSFT) has $95.5 billion in its coffers, while Google (GOOG) has $69.5 billion. Cisco (CSCO), meanwhile, has cash and equivalents of $53 billion.
This gives the mature tech companies (IYW) the flexibility to dole out dividends, spend on research and development, and still have cash for expansion. These companies also have relatively low debt levels.
The graph above shows the debt-to-equity (or DE) ratio of several top technology companies. It suggests that the broader markets are much more leveraged than tech stocks.
Facebook (FB) has negligible debt on its books, while Google, Intel (INTC), Apple, and Microsoft have slightly higher DE ratios of 5%, 24%, 29.5%, and 30.1%, respectively.
The S&P 500 Information Technology Index has a DE ratio of 33.7%. The S&P 500 (SPY) is much more highly leveraged with a DE ratio of 106.6%, which means more debt than equities. Clearly, technology stocks are, in general, far less leveraged than the other stocks in the S&P 500.
Debt is a cheaper source of capital than equity. So a higher proportion of debt will lead to a lower cost of capital. But if interest rates rise, resources could become strained, as debt payments are compulsory. That’s why a higher ratio could be risky.
Given the amount of cash that mature tech companies have, they can afford to increase their debt levels. This gives them an extra edge over the broader market.
Read 5 Reasons Why the NASDAQ’s 5,000 Level is Different This Time for more on why the tech sector could outperform.
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