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Is Tech Over-Valued?

Written by: Sean Hyman

Article Overview: How much more upside potential is there after a 67% monster rally for the technology sector? After all, there are resistance levels the market tends to respect. With slashed semiconductor demand, weak earnings reports from Dell, and an uncertain holiday shopping season ahead, is the tech sector overvalued?

Is Tech Over-Valued?

Is The Tech Sector Over-valued?

"Good new technologies are a bit like good new roads: their social benefits far exceed what any one person or company can get paid for creating them."

-- Michael Lewis, author of Liar's Poker

How much more upside potential is there after a 67% monster rally for the technology sector? After all, there are resistance levels the market tends to respect. With slashed semiconductor demand, weak earnings reports from Dell, and an uncertain holiday shopping season ahead, is the tech sector overvalued?

Top 10 Technology ETFs (by Assets)

Fund Name (Ticker) Net Assets Earnings Growth Rate (ttm)

PowerShares QQQ (QQQQ) 16.22B 15%

Tech Select Sector SPDR (XLK) 3.73B 11%

iShares Dow Jones US Tech (IYW) 1.26B 13%

UltraShort QQQ ProShares (QID) 1.07B N/A

Semiconductor HOLDRs (SMH) 968.79M 14%

Vanguard Information Tech (VGT) 736.15M 13%

iShares Dow Jones US Telecom (IYZ) 453.34M 6%

iShares S&P Global Tech (IXN) 375.14M 13%

iShares S&P North Amer Tech (IGM) 372.86M 13%

Internet HOLDRs (HHH) 350.48M 15%

Top Holdings in Tech ETFs

I compiled the 6 largest tech ETFs' top 10 holdings and their percentages of assets (data collected from Yahoo Finance). While QQQQ is not a technology-specific ETF, it tracks a tech-heavy index -- the Nasdaq 100. These ETFs are more or less the same: they all include the same tech giants such as Apple, Cisco, Google, Intel, Microsoft and Oracle, etc.

Company (Symbol) QQQQ XLK IYW VGT IXN IGM

Apple Inc. (AAPL) 14.9 8.1 9.0 7.3 6.9 8.1

AT&T INC. (T) n/a 7.8 n/a n/a n/a n/a

Cisco Systems, Inc. (CSCO) 3.1 6.6 7.5 6.4 5.5 6.6

E M C CP (EMC) n/a n/a 2.0 1.5 n/a 1.7

Gilead Sciences, Inc. (GILD) 2.7 n/a n/a n/a n/a n/a

Google Inc. (GOOG) 4.7 5.8 6.5 5.3 4.9 5.8

HEWLETT PACKARD CO (HPQ) n/a 4.6 4.8 5.2 4.6 5.5

Intel Corporation (INTC) 2.5 4.6 6.0 5.4 4.5 5.4

INTL BUSINESS MACH (IBM) n/a 7.7 8.8 7.9 6.5 7.7

Microsoft (MSFT) 5.1 9.8 11.3 9.4 8.3 8.8

Oracle Corporation (ORCL) 2.8 4.0 4.2 4.5 3.3 3.9

QUALCOMM (QCOM) 5.8 n/a 4.0 3.8 3.1 3.7

Research In Motion (RIMM) 2.5 n/a n/a n/a n/a n/a

Samsung (SSNLF.PK) n/a n/a n/a n/a 4.2 n/a

Teva Pharmaceutical (TEVA) 2.4 n/a n/a n/a n/a n/a

VERIZON COMMUN (VZ) n/a 4.2 n/a n/a n/a n/a

% of Total Assets 46.5 63.3 64.2 56.9 51.8 57.1

Tech Sector is Fairly Valued

Below are the major tech companies' fundamental data. Even though their average trailing P/E of 31 is too high, their forward P/E of 18 is reasonable.

Company (Symbol) P/E Forward P/E (1yr) PEG P/S

Apple Inc. (AAPL) 32 21 1.4 4.9

Amazon.com (AMZN) 76 51 2.7 2.6

Cisco Systems (CSCO) 24 15 1.6 3.9

Dell (DELL) 15 11 1.3 0.6

E M C CP (EMC) 34 15 1.4 2.5

Google Inc. (GOOG) 37 22 1.2 8.0

HEWLETT PACKARD (HPQ) 17 12 1.2 1.0

Intel Corporation (INTC) 47 13 2.4 3.3

INTL BUSINESS MACH (IBM) 13 12 1.4 1.8

Microsoft (MSFT) 19 14 1.5 4.7

Oracle Corporation (ORCL) 20 13 1.2 4.9

QUALCOMM (QCOM) 47 18 1.2 7.2

Research In Motion (RIMM) 17 12 0.8 N/A

Average 31 18 1.5 3.8

Mobile

There's been a significant jump in the number of people using mobile devices to access the Internet and even Dell has officially announced its entry into the Smartphone market. Mobile Internet ad spending is also expected to increase four-fold over the next 5 years. Google continues its expansion into this area. Its sponsored listings have started to appear on the iPhone.

However, the mobile internet user experience is not enjoyable because of small screen size, slow text input, and download delays. An iPhone owner can use 10 times the network capacity used by the average Smartphone user. The result is dropped calls, spotty service, delayed messages, and glacial download speeds as AT&T's network strains to meet the demand, according to the New York Times.

Online Retailers & Search

Consumers are increasingly plugged-in to online retail research and deal hunting. The economy and unemployment will accelerate their thrifty behavior.

Many companies employ search engines as not only the top method of attracting new customers, but also it is the most efficient channel for doing so. Google keeps expanding its universe: Google Commerce Search is its first significant foray into site search for retailers.

With a forward P/E of 51, Amazon seems overpriced. Its Kindle is going to be challenged by Sony (SNE), which plans to grab 40% market share in 2012 for its electronic reading devices.

Software vs. Hardware

The business models for hardware and software are fundamentally different. In hardware, you can always hope to invent your way out of any jam and keep the growth engines going. For example, Intel may be able to keep up with the "double performance every 18 months", or so called Moore's Law. In software, you need to get an early lead because winner usually takes all. Google is entering the operating system game with its upcoming Chrome OS.

Conclusion

Investors have access to the same information. They invariably head for the exits at the same time. Economic expansion might slow to a crawl. Recovery may turn out to be tepid. Nonetheless, innovation is the key to bring in solid earnings, even in a slow-growth economy.

Sun Microsystems (JAVA) used to be a top-holding in almost every mutual fund. If you bought Yahoo! (YHOO) at $500.13 per share (pre-split) during tech bubble, it is unlikely you will recover your investment. With average PEG ratio of 1.5, the tech sector overall is fairly valued. ETFs might be a great way to build your portfolio, unless you can find well-run companies at bargain-basement prices.

Disclosure: I have long position on QQQQ. Data are from iShares, Yahoo and Google Finance as of November 20, 2009.

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