Sector Analysis 3Q16
The Information Technology sector ranks fourth out of the ten sectors as detailed in our 3Q16 Sector Ratings for ETFs and Mutual Funds report. Last quarter, the Information Technology sector ranked fourth as well. It gets our Neutral rating, which is based on an aggregation of ratings of 29 ETFs and 123 mutual funds in the Information Technology sector as of July 14, 2016. See a recap of our 2Q16 Sector Ratings here.
Figures 1 and 2 show the five best and worst rated ETFs and mutual funds in the sector. Not all Information Technology sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 25 to 383). This variation creates drastically different investment implications and, therefore, ratings.
Investors seeking exposure to the Information Technology sector should buy one of the Attractive-or-better rated ETFs or mutual funds from Figures 1 and 2.
Figure 1: ETFs with the Best and Worst Ratings – Top 5
* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.
Figure 2: Mutual Funds with the Best and Worst Ratings – Top 5
* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.
Fidelity Advisor Communications Equipment Fund (FDMIX, FDMCX, FDMTX) and Saratoga Advantage Technology & Communications Portfolio (STPIX) are excluded from Figure 2 because their total net assets (TNA) are below $100 million and do not meet our liquidity minimums.
First Trust NASDAQ Technology Dividend Index Fund (NASDAQ:TDIV) is the top-rated Information Technology ETF and Fidelity Select Communications Equipment Portfolio (FSDCX) is the top-rated Information Technology mutual fund. Both earn a Very Attractive rating.
ARK Innovation ETF (NYSE:ARKK) is the worst rated Information Technology ETF and Dreyfus Technology Growth Fund (DTGRX) is the worst rated Information Technology mutual fund. ARKK earns a Dangerous rating and DTGRX earns a Very Dangerous rating.
491 stocks of the 3000+ we cover are classified as Information Technology stocks.
Juniper Networks (NYSE:JNPR: $23/share) is one of our favorite stocks held by FSDCX and earns a Very Attractive rating. JNPR is on July’s Most Attractive Stocks list as well. Over the past decade, Juniper has grown after-tax profit (NOPAT) by 12% compounded annually. Juniper has improved its return on invested capital (ROIC) from 4% in 2005 to 12% in the last twelve months.
Furthermore, the company generates significant free cash flow, $3.9 billion over the last decade. Despite the fundamental strength of the firm, JNPR remains undervalued. At its current price of $23/share, JNPR has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means that the market expects Juniper’s NOPAT to permanently decline by 30%. If Juniper can grow NOPAT by just 3% compounded annually for the next decade, the stock is worth $33/share today – a 43% upside.
ACI Worldwide (NASDAQ:ACIW: $20/share) is one of our least favorite stocks held by UNSCX and earns a Very Dangerous rating. ACIW was recently featured in the Danger Zone as well. Over the past decade, ACIW’s economic earnings have declined from $3 million in 2005 to -$26 million in 2015. Over the last twelve months, economic earnings have fallen even further to -$48 million.
The company’s ROIC peaked in 2006 at 14% and has since declined to a bottom-quintile 5%. Despite the deterioration of the business, ACIW is priced for significant profit growth. To justify its current price of $20/share, ACIW must grow NOPAT by 10% compounded annually for the next 11 years. This expectation seems overly optimistic compared to ACIW guiding for 4-7% organic revenue growth in 2016 and achieving organic revenue growth of only 3% in 2015 and -2% in 2014.
Figures 3 and 4 show the rating landscape of all Information Technology ETFs and mutual funds.
Figure 3: Separating the Best ETFs from the Worst ETFs
Figure 4: Separating the Best Mutual Funds from the Worst Mutual Funds
Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.