Investors enjoyed outstanding gains in tech stocks in 2017, but the question remains: will the run continue or is it time to take chips off the table?
Before we look to what is ahead for tech stocks, let’s review what has happened over the last few months. It is important to understand how we got here today as that is the foundation for where we are headed.
Blowout Q3 Earnings
Big cap tech stocks absolutely crushed earnings reports in the 3rd quarter. The biggest of the big were leading the way and many pundits suggested that a trickle down to the smaller players was inevitable.
In fact, solid earnings from the big cap tech stocks silenced almost all talk of “stretched” valuations, the linchpin of the bear case against tech stocks.
Tech Sector Rotation
Despite a strong showing from the top end of tech, investors started rotating out of those very names around mid-November. Even strong tech names that had good fundamentals and a solid story behind them were being sold. Investors who wanted to be in the exact right place at the exact right time rotated out of tech stocks in an attempt to squeeze every cent possible out of the market.
Tech stocks that did very well over the last 90 days or so just found their way into the crosshairs of sellers.
The sell-off was fairly widespread, with many microchip names getting a little extra on the way down. That was most likely a result of the huge run in chip names over the last year or two.
More . . .
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Don’t Call Them Value Plays!
The result of a sector rotation is almost always lower prices and lower multiples. This is the type of thing that makes the buyers of the dip salivate!
This time, however, is different. Tech stocks were already looking at very reasonable valuation multiples following the strong Q3 numbers. The sector rotation made many of these same names that much cheaper. Now looking forward, the lower tax rates are sending forward multiples down even lower.
These tech stocks that have performed better than ever in terms of business execution have seen prices come down thanks to the sector rotation, and now valuation multiples are also falling thanks to lower taxes and higher earnings estimates.
Earnings season kicks off again soon. This is the time we must make a plan and commit to it. Right off the bat, investors got a look at the latest tech gadgets and gizmos at CES (Consumer Electronic Show) in Las Vegas.
Shortly after that is another earnings season and end-of-year reports. Preannouncements in the next week or so will give us an idea of the tech landscape, but after that it becomes more about guidance than anything else.
I am expecting a lot of surprises this upcoming earnings season. There is huge potential for guidance to come in ahead of expectations for dozens of companies, and with that the strong potential for outperformance. But after reporting earnings beats, even under-the-radar stocks have a way of gaining a lot of visibility. So it is important to remain diligent about looking for something most people are not, then determining how to best play them.
Having a good earnings history is only the start of the stock-selection process. For the best results, we leverage the Zacks Rank. It instantly tells me if a stock is seeing positive or negative earnings estimate revisions. Clearly, I want to see stocks with estimates moving higher as opposed to lower.
At the end of the day, there are thousands of stocks that are seeing higher revisions. The Zacks Rank helps me cut right to the top of the list of stocks that have the “best” revisions higher. And when I think about the tech stocks that have sold off in the recent sector rotation, I look for those that have the highest Zacks Rank as potential additions to my portfolio.
In addition, I look for margin improvement over the last few years. These companies have to continuously improve their position in the marketplace.
Finally, I like stocks that beat and raise. It is like 6 months of goods news all in one day. When things end better than expected as witnessed by an earnings beat, it often leads to future months predicted to be better than expected as witnessed by the raise in guidance. Combine those two factors and you have a great chance for a post earnings drift higher.
How to Get Started
Some of the biggest gains of 2017 were in tech, and that looks like it will be true again this year thanks to strong industrial demand, consumer spending and new innovations in the tech space.
If you want to capitalize on one of the most profitable and fastest-growing S&P 500 sectors, this upcoming earnings season is a great time to get started.
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Brian Bolan is our aggressive growth expert and the editor of the Zacks Technology Innovators portfolio.