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A Buying Opportunity for Tech Stocks?

The average technology stock trades 15% below analysts' fair value estimate for the shares compared with a 3% premium at the end of September

Brian Colello, CPA 3 January, 2019 | 8:23AM

Technology Has Pulled Back and Looks Attractive Again

Technology names took a beating in the fourth quarter, with the Morningstar Global Technology Index down 18% through December 20 as concerns about a US-China trade war have put pressure on tech stocks.

We believe that tariffs have led to worries about both the health of the Chinese consumer and potential disruptions to a highly interwoven tech supply chain that would be quite difficult for the US and China to unwind. In general, tech looks a lot cheaper than it did a few months ago.

The median technology stock trades 15% below our fair value estimate today compared with a 3% premium at the end of the third quarter. Meanwhile, the number of significantly undervalued five-star tech stocks has more than doubled, with 4% of our coverage now in strong buy territory.

Opportunities are most plentiful in semiconductors, with the median stock trading at a 23% discount. The near-term picture in semis is relatively weak after a couple of years of tremendous growth. New-car sales have been sluggish in recent months, while commentary from suppliers suggests a down year for Apple (AAPL) iPhone unit sales.

Nonetheless, we foresee no slowdown in demand for more processing power, connectivity, and sensing capabilities in a wide variety of devices, such as automotive, all of which bodes well for long-term chip demand.

We generally view these cyclical downturns as the times to buy high-quality leaders, as such firms remain well positioned to weather the storm. Among chip equipment companies, memory chipmakers like Samsung were huge spenders in 2017 and much of 2018, but an inevitable pause appears in the cards for 2019.

Yet looking at stock prices across the industry, we think the market is assuming that chip equipment revenue will never recover to 2018 levels, whereas we foresee a recovery at some point down the road as leading chip manufacturers start investing again.

Finally, the median online media name also appears about 20% undervalued to us. Data and privacy concerns have weighed on US bellwethers like Alphabet (GOOGL) and Facebook (FB), while the health of the Chinese economy has made regional champions like Tencent and Baidu undervalued in our eyes, as well.

Tencent (00700)

We think wide-moat Tencent has numerous growth opportunities behind our forecast 10-year revenue compound annual growth rate of 19% and our adjusted operating profit compound annual growth rate of 20%. We think the current pause in game approval in China is due to a restructuring of the government departments with no intention to target Tencent specifically.

We estimate that approval will resume in mid-2019, which is when we will see a substantial pickup in gaming revenue. In the meantime, Tencent's network effect continues to be very strong with more than 1 billion Wechat/Weixin monthly users.

Microchip Technology (MCHP)

We view wide-moat Microchip Technology as one of the highest-quality firms under our semiconductor coverag and see an attractive margin of safety for investors after a recent pullback across our broad-based semiconductor coverage. Microchip remains a leading supplier of the "brains" needed for a variety of smart devices categorized as the "Internet of Things."

We find Microchip under the hood, figuratively and often literally, of the latest cars with the most advanced electronics and think it is poised to profit from rising chip content per vehicle. Microchip is adept at navigating the various industry cycles and, at this point, we see no reason this latest potential industry slowdown will impact the stock.

KLA-Tencor (KLAC)

We believe wide-moat KLA-Tencor's shares are trading at an attractive discount. KLA-Tencor dominates the PDC, or process diagnostic and control, segment of the semiconductor equipment industry. During the chip fabrication process, wafers must be inspected for defects and proper critical dimensions to identify and correct problem sources. As customers pursue Moore's law, smaller chips must meet increasingly precise specifications, which increases the need for advanced PDC tools and bodes well for future demand for KLA.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Alphabet Inc A1,244.41 USD-0.67
Apple Inc236.28 USD0.43
Facebook Inc A185.88 USD-2.37
KLA Corp159.69 USD-1.13
Microchip Technology Inc95.01 USD-0.72
Tencent Holdings Ltd331.00 HKD0.00

About Author

Brian Colello, CPA  is a senior stock analyst with Morningstar.

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