Technology: Shift to Cloud Computing Most Important Story

• Overall, we view the tech sector as modestly overvalued at a market-cap-weighted price/fair value of 1.08
• Enterprise cloud computing remains the most important story in tech
• Consolidation remains at the forefront in technology, particularly in semis and software
• Changes to U.S. tax laws should lead to even more attractive capital allocation policies

Overall, we view the tech sector as overvalued today at a market-cap-weighted price/fair value of 1.05 as of the end of February versus 1.08 at the end of November and 1.09 at the end of August. The Nasdaq index has risen about 6% from mid-December to mid-March and is up about 6% year to date in 2018.

We’ve seen some fits and starts among large-cap tech leaders.

Enterprise software and IT Services are still interesting growth sectors to us, and we still see a handful of undervalued names in these spaces, including

In our view, the single most important trend in technology remains the ongoing shift toward cloud computing, which we think is having ramifications on dozens of stocks across our coverage. In short, both startups and enterprises, in efforts to reduce the high fixed costs associated with running on-premises IT hardware and software, are shifting more and more workloads to infrastructure-as-a-service vendors, such as Amazon AMZN Web Services, Microsoft Azure, and Google. In turn, IaaS vendors, along with software-as-a-service vendors, are seeing tremendous growth while legacy IT vendors face ongoing headwinds. In SaaS,

Another ongoing trend within technology remains mergers and acquisitions. We saw a tantalizingly newsworthy, but ultimately unsuccessful, attempt by

Finally, changes in U.S. tax laws are likely to be a huge boost to technology firms, as global tech leaders are able to repatriate overseas cash into the U.S., which can be used for dividends, share repurchases, and potentially even more M&A. Apple has the world’s largest cash cushion, and we were stunned by the firm’s proclamation that it intends to run the business at net cash-neutral, meaning that the firm has $163 billion of cash to either invest or return to shareholders. Cisco also announced a massive $67 billion repatriation of cash back into the U.S. and similarly authorized a $25 billion share-repurchase plan.

Top Picks

Guidewire Software

GWRE

Star Rating: 4 Stars

Economic Moat: Wide

Fair Value Estimate: $100

Fair Value Uncertainty: Medium

5-Star Price: $70.00

Guidewire's recent investments to improve its positioning as a cloud vendor solidify our belief that the firm will continue to win substantial market share in the property and casualty insurance software market. We believe Guidewire's holistic platform and proven excellence at the top of the insurance market, coupled with the mission-critical nature of its core application offerings, yield a wide economic moat for the firm. While these solutions have primarily been deployed on-premises historically, the company's latest release of InsuranceSuite is fully standardized on Amazon Web Services, and Guidewire recently struck a partnership with Salesforce to integrate its applications with Salesforce's best-of-breed CRM platform. We believe these moves will provide further inroads into the Tier 1 and 2 insurance market, where we believe the bulk of addressable market opportunity resides. We believe Guidewire can easily consume upwards of 30% market share in this market over the next 10 years, yielding more than $1.5 billion in annual software revenue by the end of our explicit forecast period.

Sabre

SABR

Star Rating: 4 Stars

Economic Moat: Narrow

Fair Value Estimate: $26

Fair Value Uncertainty: Medium

5-Star Price: $18.20

We believe that market fears regarding a weakened competitive position for Sabre are exaggerated and that the company’s network effect, efficient scale, and switching cost advantages are intact, leaving investors the opportunity to own the narrow-moat firm at a sufficient margin of safety. Sabre's shares faced turbulence in 2017 as the company was hit with some lost business and incremental cloud infrastructure investment. But we see these headwinds as largely temporary and believe the operator’s underlying competitive positioning is intact. This view is supported by Sabre continuing to announce new wins, validating its technology offering. Additionally, incremental cloud investment is showing early signs of yielding a less capital-intensive business, and we have confidence that Sabre will be able to execute on efficient technology spending with new executive hires that have completed technology revitalization at other companies in the past. Industry anxiety that the move to new distribution capability will foster an increase in airline direct bookings is unfounded, in our opinion. This view is reinforced by commentary provided by major agencies and airlines that highlights the difficulty in replicating the network effect that global distribution system operators have developed in an efficient manner, supporting these competitive advantages that we award Sabre and its peers in the industry.

Motorola Solutions MSI

Star Rating: 4 Stars

Economic Moat: Narrow

Fair Value Estimate: $127

Fair Value Uncertainty: Medium

5-Star Price: $88.90

Following the split from Motorola Mobility and years of mergers and acquisitions, Motorola Solutions has established a formidable niche as the dominant supplier of land mobile radio technology for law enforcement, firefighters, and emergency first responders, carving out an estimated 80% market share in the United States. Motorola Solutions has divested itself of low-margin segments while doubling down on emergency communications infrastructure and two-way radios and expanding its software-as-a-service offerings. After some growing pains from restructuring, the company now generates more attractive returns on invested capital and benefits from tight customer relationships with city, state, and federal governments, in addition to brand equity, thanks to its established legacy of reliability in mission-critical situations. We believe this shift into mission-critical offerings and software build-out through internal R&D and acquisitions has largely been underappreciated for Motorola, and we forecast mid-single-digit revenue growth and continued operating margin expansion. We see emergency equipment largely as a nondiscretionary spending item and assert that technological disruption typically has a muted impact on public-sector services, lending credence to our narrow economic moat rating.

Quarter-End Insights

Stock Market Outlook: Stocks Look Slightly Overvalued Today 4- and 5-star stocks are harder to come by in today's market, but a few values are still out there.

Credit Market Insights: A Decidedly Negative Quarter for Fixed-Income Markets Rising rates and widening credit spreads took their tool in the first quarter of 2018.

Basic Materials: Still Overvalued Despite Protective Tariffs Our bearish view on the mining and metals sector means the basic materials coverage universe trades at a market-cap-weighted 30% premium to our fair value estimates.

Communication Services: The Most Undervalued Sector We Cover We see value in several firms as consumers migrate away from traditional TV bundles and Europe invests in fiber and 4G.

Consumer Cyclical: Confidence, Demographics Support Consumption Gains E-commerce market share gains present challenges for some, but trends continue to support healthy profitability for many companies.

Consumer Defensive: Looking to M&A, Online Sales for Growth We see a few values for long-term investors amid intense competition.

Energy: Looming U.S. Shale Supply Should Temper Optimism Huge output decline boosts near-term fundamentals, but lofty prices likely to trigger dangerous shale growth later.

Financial Services: Regulations and Interest Rates Remain in the Spotlight for 2018 We see financial services stocks across the globe as fairly valued today.

Healthcare: Values Among Drug, Biotech, and Supply Chain Firms Innovation, consolidation, and a mixed regulatory picture for healthcare stocks in the first- quarter.

Industrials: Healthy Demand, But Few Values Among a mostly fairly valued industrials sector, some good values remain.

Real Estate: Rising Rates Won't Derail Strong Fundamentals REITs have focused on strengthening their portfolios, deleveraging, and capital recycling in the face of higher bond yields and new construction.

Utilities: Under Pressure in Early 2018 Utilities sell-off presents opportunities for long-term investors.

Venture Capital Outlook: Despite Slow Volume, Liquidity Prospects Remain We expect ample opportunity in the VC-backed IPO market as alternative liquidity routes gain popularity.

Private Equity Outlook: Carveouts on the Rise as Fundraising Slows As dealmakers look to innovate their origination process, we anticipate a continued rise in take-privates and corporate divestitures.