Does Value Investing Work in the Technology Sector?

Does Value Investing Work in the Technology Sector?

Wesley R. Gray, Ph.D. 05/16/2014 09:53

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A recent blog post suggests that value investing in the tech sector is a waste of time.

The article tells a compelling story and argues for 2 points:

Successful tech stock investing is done when the stocks are dear, not when they are cheap.

Tech companies should not get credit for huge piles of cash on their balance sheets.

The author then makes the claim that you can’t make big money in cheap tech stocks and buying cheap tech doesn’t work. We thought the blog post was thought-provoking and it inspired us to conduct a quick empirical analysis to ascertain if there was any truth to the claims.
Do value-investing principles matter in the technology space?

First, a quick description of the study we conduct from 1980-2013.
Identify firms above NYSE 20th percentile for market cap that have information to calculate enterprise multiples.
In today’s terms, this equates to a universe that looks at stocks with a market capitalization of $790mm and up. 

Split firms into deciles based on EBIT/TEV

Only example firms with SIC codes related to the high-technology sector
5 HiTec Business Equipment — Computers, Software, and Electronic Equipment
3570-3579

3622-3622 Industrial controls

3660-3692

3694-3699

3810-3839

7370-7372 Services – computer programming and data processing

7373-7373 Computer integrated systems design

7374-7374 Services – computer processing, data prep

7375-7375 Services – information retrieval services

7376-7376 Services – computer facilities management service

7377-7377 Services – computer rental and leasing

7378-7378 Services – computer maintanence and repair

7379-7379 Services – computer related services

7391-7391 Services – R&D labs

8730-8734 Services – research, development, testing labs

What do the results look like?

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The chart above clearly shows there is a relationship between price paid and future performance. The cheapest decile of tech firms earn 15.25% a year, on average, whereas, the expensive decile tech firms earn 1.89%/year. Certainly seems to refute the argument proposed by the author that value investing doesn’t apply to tech firms… Here are some additional statistics comparing the most expensive decile, the mid-range decile, and the cheap decile.

NYSE 20 EW EBIT 10 = equal-weight, annual rebalanced portfolio of cheapest EBIT/TEV tech stocks

NYSE 20 EW EBIT 5 = equal-weight, annual rebalanced portfolio of 40-50% EBIT/TEV tech stocks

NYSE 20 EW EBIT 1 = equal-weight, annual rebalanced portfolio of most expensive EBIT/TEV tech stocks
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Here are the annual returns for the 4 return streams from 1980 to 2013. You’ll notice some dramatic swings in relative performance around the Internet Bubble!

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

WESLEY R. GRAY, PH.D.

Dr. Gray has been an active participant in financial markets for over 15 years. His experience includes positions as a Captain in the United States Marine Corps, as a finance professor at Drexel University, and as a portfolio manager for a special-situations hedge fund. Education and entrepreneurship has been the focus of his professional endeavors and his research interests are focused on the performance of portfolio managers and behavioral finance. Dr. Gray is currently the Executive Managing Member of Alpha Architect, an SEC-Registered Investment Advisor. Dr. Gray has published two books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army and QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors. His work has been highlighted on CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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