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Tech Sector Now Decently Undervalued

Tech Sector Now Decently Undervalued
Securities In This Article
Tyler Technologies Inc
(TYL)
Microsoft Corp
(MSFT)
ServiceNow Inc
(NOW)
Micron Technology Inc
(MU)
Palo Alto Networks Inc
(PANW)

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Brian Colello: Looking at technology as of March 26, the U.S. Technology index over the past year is still up 11%. Meanwhile, the equity market is down 6%. If we look at both markets on a year-to-date basis, since Jan. 1, tech is down only 10%, whereas the equity market is down 19%, again as of March 26.

Looking at the median tech stock, we think the median is 13% undervalued on a price to fair value basis. Hardware stocks within technology are down 16%, software is down 14%, and semiconductors are 8% below our fair value estimate, again, on a median basis. Now, a quarter ago, the median tech stock was 7% overvalued, and we saw no attractive sectors within technology. So in our view, technology has shifted from being modestly overvalued to decently undervalued, especially for investors that have a long-term time horizon.

We like wide-moat names like Microsoft, Salesforce, ServiceNow, and Tyler Technologies. All have wide moats. All have very sticky customer bases. And revenue is on a subscription basis and recurring, so there shouldn't be too many interruptions to existing users as they shift to working remotely, and a good portion of this revenue is on a deferred revenue basis, so there's good visibility. Cybersecurity is another area we like, names like Palo Alto Networks, Okta, and CrowdStrike. They also have recurring revenue similar to these software names, but also their security solutions are becoming more and more important as employees work remotely.

For earnings ahead, all eyes will naturally be on COVID-19 and the demand outlook for technology. Many companies have pulled guidance. Few have actually provided updated guidance into the June quarter. There's very little visibility as you can imagine. But looking at a company like Micron, which reported a couple of weeks ago, data center demand still appears to be strong, PC demand actually seems decent as people prepare to work remotely, and smartphone demand is a bit softer, but there's still anticipation of a bounceback later in the year.

Looking at the automotive sector, that's probably the one area of weakness within technology because a lot of sensors and semiconductors go in there. Car sales in the month of March in the U.S. were down over 30% for firms like Toyota and Volkswagen, so we'll see how bad the headwinds are in the coming weeks for automotive chip demand and sensor demand.

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About the Author

Brian Colello

Strategist
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Brian Colello, CPA, is an equity strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. In addition to leading Morningstar’s technology sector team, he covers semiconductor and hardware companies. Colello was a senior equity analyst before assuming his current role in 2015.

Before joining Morningstar in 2008, he worked in public accounting for KPMG and served as a manager in corporate finance for BMG Music, a subsidiary of Bertelsmann AG.

Colello holds a bachelor’s degree in accounting from Bucknell University and a master’s degree in business administration from Wake Forest. He is also a Certified Public Accountant.

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