Information technology (IT) is the most undervalued sector in the S&P 500 (INDEXSP:.INX) according to Goldman Sachs’ latest Quarterly Chartbook. “We forecast the S&P 500 will end 2014 at 1900 (+3%), and believe Consumer Discretionary, Industrials, and Information Technology stocks will outperform the index. We expect US GDP growth to reach 3.0%,” the report says.
Goldman found that the implied EPS growth rate for IT has been 6.6% higher than the S&P 500 (INDEXSP:.INX) over the last decade, but its current implied EPS growth rate is just 0.8%. The idea is that implied EPS growth is the level necessary to justify current stock prices, calculated by inverting a two-stage dividend discount model. Since the current rate for IT is significantly less than the historical average, you could consider the sector to be undervalued.
Implied EPS growth rate also indicates cheap valuations
For value investors who are used to always looking at PE multiples, implied EPS growth rate gives similar information. Both measures give you a sense of how much growth is already being factored into a stock price, and in both cases stocks that don’t have a lot of growth built into the existing price are closer to the underlying value of the company’s assets.
Even though we normally think of huge IT companies (Apple, Google) or the exciting growth story (Twitter), IT is actually extremely diverse when measured by equity capitalization. An investor looking for deals could do well to look in sub-sectors like systems software or semiconductors to find companies that don’t get as much mainstream press, but represent a big part of the sector.
The largest sub-sector, computer hardware, was one of the few that didn’t manage to outperform the index. Office electronics outpaced every other IT sub-sector, followed by home entertainment software, data processing & outsourced services, and internet software & services.
Goldman’s picks for highest 2014E earnings growth
Goldman lists Applied Materials, Inc. (NASDAQ:AMAT), salesforce.com, inc. (NYSE:CRM), Facebook Inc (NASDAQ:FB), Lam Research Corporation (NASDAQ:LRCX), and Computer Sciences Corporation (NYSE:CSC) as the IT companies with the highest expected 2014 earnings growth, though these aren’t necessarily the best IT value stocks available, either in the sense of having a low PE multiple or a low implied EPS growth rate.