What are we looking for?
U.S. stocks from the technology sector that still have room for growth.
The screen
With the S&P 500 information technology sector total return index up more than 30 per cent so far this year, it's no wonder investors are concerned about tech stocks being overvalued. Memories of the tech bubble of the late nineties are enough to make any investor think twice about what they're investing in.
Today, I'm showcasing a strategy that looks for U.S. tech stocks that aren't overvalued and show signs of further price appreciation. This strategy looks only at stocks within the Morningstar Technology sector – a universe consisting of 355 stocks today.
Stocks are ranked based on their trailing return on equity (ROE) and must meet the following criteria:
- Trailing price-to-earnings value must be lower than at least 50 per cent of all technology stocks (this is to avoid stocks that are overvalued – today, a P/E ratio less than 26.8 would satisfy this criterion);
- A trailing dividend payout ratio less than 60 per cent (to prevent buying companies that are paying out too much of their earnings);
- A debt-to-equity ratio less than one (to avoid companies with too much leverage).
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back-test this strategy from December, 1996, to September, 2017. During this process, a maximum of 15 stocks were purchased. Stocks were sold if their dividend payout ratio grew to 80 per cent or higher or if their debt-to-equity ratio rose above 1.3. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 16.7 per cent while the S&P 500 IT sector total return index returned 9.1 per cent across the same period. Stocks that qualify for purchase into the strategy today are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan is an account manager for CPMS at Morningstar Research Inc.