Why tech stocks could score this September

With September underway, many equity analysts are raising the red flag -- because historically the month is one of the worst for the stock market. To the optimists, however, that spells great opportunity to hunt for fundamentally sound stocks selling at a discount. 

Since 1945, the S&P 500 index has posted its weakest monthly price performance in September, falling an average 0.66 percent versus an average gain of 0.66 for all months and declining in price 57 percent of the time, according to Sam Stovall, chief equity strategist at S&P Global Market Intelligence.

September saw the second-worst single-month price drop of 11.9 percent in 1974, he noted, and what’s more, August and September accounted for one-third of all monthly declines of 5 percent or more.

So for intrepid investors in search of reasonably priced stocks for the long term, September looks like the month they should be buying. And the technology stocks, which dominated on the upside when the major market indexes were posting multiple all-time highs earlier this year, now appear to be attractively valued because most have pulled back since those highs.

Since Aug. 1, tech stocks overall trailed the better-performing sectors such as the telecom group, which has advanced more than 16 percent, and utilities, which gained over 15 percent. Even the beleaguered energy stocks did better than the techs, climbing more than 15 percent versus the tech sector’s 9 percent.

“The tech sector lagged as investors rotated to value-oriented cyclical stocks in anticipation of a macroeconomic bounce,” noted Lisa Shalett, head of Investment and Portfolio Strategies at Morgan Stanley Wealth Management, in her recent Global Investment Committee (GIC) weekly report. “Institutional investors downplayed the tech sector,” she said. Morgan Stanley’s own chief U.S. equity strategist has technology as his largest “underweight” recommendation, citing negative sales growth and a dearth of stock-selection ideas, Shalett noted.

“As a result of this pessimism, relative forward multiples for technology stocks are at levels last seen in 2003,” Shalett added. “So in an environment of record-low global yields and increasingly unattractive valuation among traditional defensives and bond proxies, the GIC believes this could spell opportunity,” she said.

The tech sector boasts of high free cash flow with low yields and low overall payout ratios -- “a combination that suggests capacity for solid growth in shareholder returns through dividends and buybacks,” Shalett said. She believes earnings in the tech sector “will have an upside surprise because of stronger demand, positive operating leverage and tailwinds from secular trends in capital spending.”  

The tech sector is one that S&P Global Market Intelligence rates as “overweight” in its most recent investment strategy report. Three of the tech stocks that S&P Global rates as a “strong buy” or “buy” are Apple (AAPL), which announced on Wednesday the new  iPhone7 and Apple Watch Series 2; Facebook (FB), the world’s largest and most dominant social media company; and Flextronics (FLEX), one of the world’s biggest makers of electronic components and computer products for industrial and commercial customers.

In appraising the newly unveiled Apple products, S&P equity analyst Angelo Zino said, “we positively view the new camera/audio features (dual camera on iPhone7 Plus), doubling of memory content and new AirPod technology.” Set to start shipping on Sept. 16, (a week earlier than he expected), the new products “may offer an upside to the September quarter” results, said Zino.

He noted that his “strong buy” recommendation on the stock primarily reflects Apple’s “compelling valuation” and the belief that growth will resume following the launch of iPhone7 and the company’s robust free cash flow and cash position. 

S&P believes Facebook continues to have considerable competitive advantages in social media. Because of its strong global brands, substantial user base, high levels of engagement and access to robust user data and information, the company has broad monetization opportunities, particularly in video and with Instagram. 

Facebook hit an all-time high on Wednesday, and closed down 78 cents on Thursday to $130.27. But S&P equity analyst Scott Kessler sees more upside ahead and has a 12-month price target of $155 for the stock.

At just over $7 billion, Flextronics (FLEX) has a much smaller market cap than giants like Apple ($572 billion) and Facebook ($378 billion), which can make it a little dicier for some more cautious investors. But S&P rates it a “strong buy,” saying it’s attractive on its “favorable valuation” coupled with encouraging growth prospects despite the currently soft end-market demand in the tech industry, according to Keith Snyder, S&P equity analyst. 

He’s optimistic that the company will benefit from long-term growth trends he sees in demand for electronics.

Flextronics, he noted, is making proper adjustments by shifting its focus to higher-growth and higher-margin markets, such as industrial, medical and automotive. And the company’s financial liquidity and free cash flow generation are positives that will help spur expanded growth, Snyder said. 

In sum, tech stocks should complement investors’ usual bias toward quality and value sectors in the U.S., said Morgan Stanley’s Shalett. Within the sector, she added, investors should favor software and services, and network/communications-related hardware companies. 

If picking individual stocks isn’t your comfort zone, you can use exchange-traded funds (ETFs) as an alternative. S&P equity analyst Todd Rosenbluth favors the Technology Select Sector SDPDR Fund (XLK), currently trading at over $47 a share, and First Trust Dow Jones Internet Index Fund (FDN), trading at $80 a share, due to their attractive holdings in info tech.