Information Technology Sector 4Q16: Best and Worst

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Sector Analysis 4Q16

The Information Technology sector ranks third out of the ten sectors as detailed in our 4Q16 Sector Ratings for ETFs and Mutual Funds report. Last quarter, the Information Technology sector ranked fourth. It gets our Neutral rating, which is based on aggregation of ratings of 28 ETFs and 142 mutual funds in the Information Technology sector as of October 17, 2016. See a recap of our 3Q16 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 377). 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 & Worst Ratings – Top 5

NewConstructs_ETFratings_InfoTech_4Q16

* Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

NewConstructs_MFratings_InfoTech_4Q16

* Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

Fidelity Advisor Communications Equipment Fund (FDMIX) and Saratoga 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.

iShares Global Tech ETF (IXN) is the top-rated Information Technology ETF and Fidelity Communications Equipment Portfolio (FSDCX) is the top-rated Information Technology mutual fund. Both earn a Very Attractive rating.

ARK Innovation ETF (ARKK) is the worst rated Information Technology ETF and Victory RS Science and Technology Fund (RSIFX) is the worst rated Information Technology mutual fund. ARKK earns a Dangerous rating and RSIFX earns a Very Dangerous rating.

486 stocks of the 3000+ we cover are classified as Information Technology stocks.

Oracle Corporation (ORCL: $38/share) is one of our favorite stocks held by FTEC and earns a Very Attractive rating. In February, we proposed a strategy to boost the firm’s value by $64 billion. Over the past decade, Oracle has grown after-tax profit (NOPAT) by 12% compounded annually. Oracle has consistently earned an impressive return on invested capital (ROIC) and currently earns a top-quintile 24% over the last twelve months (TTM). Despite the impressive profit growth Oracle has achieved, the firm remains undervalued. At its current price of $38/share, ORCL has a price-to-economic book value (PEBV) ratio of 1. This ratio means that the market expects Oracle’s NOPAT to never increase from current levels. If Oracle can grow NOPAT by just 3% compounded annually for the next decade, the stock is worth $48/share today – a 26% upside.

athenahealth Inc. (ATHN: $126/share) is one of our least favorite stocks held by ARKK and earns a Very Dangerous rating. We put Athenahealth in the Danger Zone in April 2015. Athenahealth’s economic earnings have declined from $1 million in 2010 to -$71 million TTM. The company’s ROIC has fallen from 11% in 2010 to a bottom-quintile 1% TTM. Despite the deterioration of the business, ATHN remains priced for significant profit growth. To justify its current price of $127/share, ATHN must immediately achieve 2.6% NOPAT margins (average last five years compared to 1.1% TTM) and grow NOPAT by 57% compounded annually for the next 14 years. This expectation seems overly optimistic for nearly any company, much less one with a history of shareholder value destruction.

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

NewConstructs_ETFratingsLandscape_InfoTech_4Q16

Sources: New Constructs, LLC and company filings

Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds

NewConstructs_MFratingsLandscape_InfoTech_4Q16

Sources: New Constructs, LLC and company filings

This article originally published here on October 17, 2016.

Disclosure: David Trainer, Kyle Martone, and Kyle Guske II receive no compensation to write about any specific stock, sector or theme.

Click here to download a PDF of this report.

Photo Credit: Jarleon-Fotografía (Flickr)

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