Post-Apple: Are Technology Shares Cheap?

Stocks were flat today, with the S&P 500 (SNPINDEX: ^GSPC  ) gaining just a hundredth of a point. The narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) was up one third of a percent, but keep in mind that it doesn't contain Apple (NASDAQ: AAPL  ) . The maker of the iPhone is the largest weighting in the S&P 500, so today's 12.3% decline in Apple shares contributed negatively to the index's performance to the tune of negative 44 basis points. (One basis point is equal to a hundredth of a percentage point.)

Technology: bitten by a bruised Apple
Not surprisingly, then, information technology was the worst-performing sector today, losing 2%; in fact, the only other sector that lost ground was telecommunication services, at -0.3%. That's not a coincidence: The two largest companies in that sector, Verizon and AT&T, are part of the "Apple ecosystem" -- both stocks were down today. Where does that leave us? The following table displays the forward price-to-earnings for each sector in the S&P 500.

Sector

Price-to-Earnings Ratio (Jan. 24)*

S&P 500 Telecommunication Services

16.5

S&P 500 Consumer Discretionary

15.8

S&P 500 Consumer Staples

15.6

S&P 500 Utilities

14.7

S&P 500 Industrials

13.9

S&P 500 Materials

13.8

S&P 500 Health Care

13.5

S&P 500 INDEX

13.3

S&P 500 Financials

12.1

S&P 500 Information Technology

11.9

S&P 500 Energy

11.8

Source: author's calculations based on data from S&P Dow Jones Indices.
*Based on estimates of 2013 operating earnings per share on Jan. 17.

Today's shakeup leaves technology as the second-to-cheapest sector in the S&P 500. At just under 12 times its earnings-per-share estimate for 2013, it's valued similarly as financials (12.1 times) and energy (11.8 times). However, relative to each sector's average price-to-earnings multiple over the past five- and 10-year periods, Technology is the cheapest sector by a wide margin; for reference, its current multiple is one-third below than its 10-year average. Obviously, Technology shares are a lay-up.

Not so fast.

Current earnings estimates for 2013 look pretty aggressive in calling for technology companies to boost earnings by nearly 20% -- the highest target growth for any sector, barring telecoms. With expected revenue growth slightly in excess of 6% (again, the highest target for all but one sector), that implies investors are looking for profit margins to expand. However, as mentioned in this column, technology is one of only three sectors in which profit margins have not (yet) fallen significantly below their highs over the past two and a half years.

Current valuations suggest there may be some opportunities in technology; however, investors can no longer count on the "Apple effect." In doing one's due diligence, one ought (as always) to assume that if shares look cheap, there is a reason for it -- it's not necessarily found money.

There's no doubt that Apple is at the center of technology's largest revolution ever and that longtime shareholders have been handsomely rewarded, with more than 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple and what opportunities are left for the company (and, more importantly, your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


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