While the Technology sector has been running hand in hand since the start of the economic recovery after the 2008-09 financial crisis and has maintained pace comfortably with the broader market - S&P, the Information Technology Services industry has been meandering its way above and below both its sector and the broader market throughout the past 5.5 years.
The number war
Where the broader market S&P 500 index has moved up some 180% since early March of 2009 post the last recession and the Technology SPDR (XLK, Financial) has gained a close 190%, the smaller two of our three IT Services companies in the battle –Â Fidelity National Information Services, Inc. (FIS, Financial) and Xerox Corporation (XRX, Financial), have outperformed considerably with gains of 250% and 200%, respectively, since the recovery.
Meanwhile, the giant amongst the three –Â International Business Machines Corporation (IBM, Financial) –Â has managed just a mere 125% gain likely due to its monstrous mega cap size, more than 10 times larger than the other two warriors.
On an annualized basis, where the S&P 500 and the Technology sector fund have averaged gains of 32.2% and 34.0% per year since March of '09, IBM has averaged, at 22.4%, way below the broader market and its peers, while Xerox has averaged at par with the broader market standing at 35.8% and Fidelity has averaged at a lofty 44.8% per year.
The Information Technology Services industry is expected to supercede the S&P 500 by a huge margin from Q4 of this year and on into the future, as indicated in the table below. Though Info Tech will be a laggard in the overall Technology sector in 2014 and 2015, it would work its way up to taking the leadership role in its sector within the next five years.
Within the Infotech sector, our three warrior stocks – IBM, Fidelity and Xerox –Â would be the underperformers and responsible for the troughs of their sectorial index in the near term owing to their slow rate of growth, which is half their sectorial peer’s growth rate. Large caps do not surge ahead as robustly as the medium and smaller caps. But compared to the broader market, their momentum would look more attractive thus resulting in higher graph movement than the S&P 500.
As an investor it would be wise to add the stock of all the three IT honchos to your portfolio to give both agility and stability to the portfolio. Decent growth gradient, as well as steady dividend income ranging from 1.80% to 2.40% per year, is what you can expect by adding the three IT companies to your portfolio. But how do the three largest U.S. Infotech services companies stand against one another, and which one should hold the lion's share of your portfolio among the three –Â let us work that out.
Trend study and future insight
While doing an analytical postmortem of the three U.S. IT bigwigs we will dissect them in three layers – firstly financial comparisons, secondly estimates and analyst recommendations and last but not the least rankings with accompanying data table.
Financial comparisons
• Market Cap: Though this is not the deciding factor of the companies ranking, however it is useful to analyze the ranking factorials and identify the actual rate of growth or de-growth of the factorials.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year and the decision of its upward or downward growth is computed.
In the last reported quarter, Fidelity's quarterly revenues and earnings outpaced the others comfortably, while the others' revenues actually took a hit.
• Profitability: A company's profit figures actually reflect how wise it would be to take a stake into the company since the earning from owning stakes would come from the profits. Of our three contestants, IBM's profit and operating margins are highest, while Xerox's fares the worst on profitability factors.
• Management Vibes: Shareholders are keenly interested in management's ability to optimize output from resources as a result generates more value for the business and its shareholders. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
In both returns on assets and on equity, IBM's management team scores the highest and the other two contenders share the second place not far behind IBM.
• Earnings per Share: Of all the metrics measuring a company's income, earnings per share is probably the closest to a shareholder’s heart because it actually reflects the company’s ability to generate value in numbers for each share Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies IBM provides common stock holders with the best diluted earnings per share gain as a percentage of its current share price with Xerox taking the second place not far behind IBM, but Fidelity lacks way behind its peers.
• Share Prices: Even if a company outperforms its peers on all the above metrics, however, average investors may still stay away from shopping such stocks which sport a premiere price tag unless due to major crisis the price tag mellows down to a reasonable size. This is where the stock price relative to forward earnings and company book value plays a decisive role, as well as the PEG ratio comes into consideration for an investor taking position. Lower ratios indicate the stock price is currently trading at economic price levels than its peers, and might thus be a good deal to lock in.
Among our three combatants, IBM has the cheapest stock price relative to forward earnings and 5-year PEG, while Xerox's is the better priced stock relative to company book value. But Fidelity's stocks at its current levels stand overpriced relative to earnings.
Market estimates and analyst view
Though we might be skilled enough to gauge a stock's prospects as an investment, we would always like to refer to a second opinion about it from professional analysts and the company’s management team for insight about estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell indicators.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three musketeers, IBM offers the best earnings percentages across all four time periods with Xerox following in, while Fidelity lags behind.
• Earnings Growth: For long-term investors this metric is one of the most useful indicators, as it denotes the percentage by which earnings are expected to appreciate or depreciate as compared to earnings from corresponding periods a year prior.
IBM and Fidelity shares the top slot in this attribute while Xerox stands a lost battle in this sector.
• Future share price levels: Like earnings estimates above, a company's stock price movement must also be converted into a percentage of its current price to get a better future view of multiple companies.
Going by analysts’ predictions Fidelity holds the best spot in this sector over the coming 12 months, while IBM falls behind in this sector with least capital appreciation and more downside risk.
• Buy/Sell Indicators: After all is said and done, one of the most important analyst recommendation culminating out of all the studies is perhaps identifying the levels at which a stock stands oversold or overbought and the exit and entry price levels of a particular stock. This is the part that decides the fate of a stock in the investor’s hand – buy, sell or hold.
Of the three stocks in focus, Fidelity is best recommended with 5 strong buys and 4 buys representing 31.25% and 25.00% of its analysts, followed by Xerox with 2 strong buys and 3 buys, while IBM though falls short of ground yet runs very close behind with 2 strong buy and 2 buy recommendations.
Rankings
After brainstorming with the number board and comparing all projections it is time to tally the inferences and rank the IT contestants.
This is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of its market cap for a fair understanding of where each company stands. For your better understanding and reference at a glance, we have compiled our study in the table below for your ready reference.
Ready synopsis for quick investors
Going by the results, it can be churned out from the above analysis that IBM holds the top slot in the victory stand- outperforming the rest in 15 metrics and underperforming in 8 for a net score of +7. Fidelity National Information Services stands second, outperforming in 12 metrics and underperforming in 11 for a net score of +1.Xerox, outperforming in just 5 metrics while underperforming in 12 for a net score of -7 cuts the sorry picture in the short to mid-term and even though its agile in its market movement, yet when a deeper analysis is done it stands out of consideration for investment purpose unless the company’s management works out on the key indicators.
All the three U.S. IT sector torch bearers offer fine growth potential, over a long term investment period, in line with the broader market S&P for years to come at better stock price valuations, with IBM promising a best return.
