Keeping up with the Gates’

With the technology sector already up 50% year to date, it is prudent for investors to re-examine the fundamental case for an investment in the industry.  We initially discussed our positive stance on information technology in our Second Quarter 2009 letter to investors (embedded below), but as consensus expectations have increased steadily since then, valuation is becoming more important as price has begun to reflect improving fundamentals. 

As one of our favorite analysts in the sector mapped out earlier this year, we believe that early investors in the sector were paid for balance sheet strength and liquidity in this year’s first quarter, and for stabilization and a better outlook in the second quarter.  Year-over-year declines started improving in the third quarter and further improvement and positive year-over-year growth are likely through the first quarter of next year.  At some point, likely early next year, the herd’s desire to Keep up with the Jones’ will translate into overly optimistic expectations and valuations that are “priced to perfection.”  We are not quite there yet, but believe investors should focus on quality and structural growth at this point in the cycle.  Until then, we’ll recap some of our favorite reasons to maintain a constructive stance on the group: 

  • Pristine balance sheets, minimal debt and the most cash of any domestic sector
  • Among the highest exposure to international and emerging market demand
  • Enterprise capex and IT spending set to improve from low levels reflecting extremely depressed budgets
  • Corporate profits improving – a leading indicator of capex
  • Tech operating margins likely to rebound strongly next year
  • Valuations for many high quality names not elevated
  • Technology’s share of market cap not high relative to the sector’s strong share of earnings

Broyhill Letter (Q2-09)