By Sam Stovall I was flipping through my 52-week relative strength charts of sectors and subindustry indexes in the Standard & Poor's Composite 1500 (S&P's total U.S. stock universe), as I usually do if I'm in search of a sector story, and came across this chart on the S&P Computer Storage & Peripherals subindex. The price action on the chart (pictured below) looked constructive to me.
Source: Standard & Poor's
As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the sub-industry index's 14-year mean relative strength.
The Computer Storage & Peripherals subindex consists of 12 companies, dominated by EMC. (EMC
; S&P investment rank, 5 STARS, strong buy; recent price, $14). During 2004, this subindex advanced 16.9%, while the S&P 1500 gained 10.0%. Since the group's relative strength looks encouraging, the question is: Is it time to tiptoe back into this area of tech?
ROOM TO GROW. It might just be. S&P equity analyst Richard Stice, CFA, has a positive fundamental outlook for the computer-storage and peripherals industry. S&P expects storage to be a high spending priority in 2005, driven in part by an increasing emphasis on data backup and replication requirements associated with Sarbanes-Oxley legislation.
In addition, Stice is encouraged by what he views as more robust capital structures for these companies, with a healthy amount of cash and investments and ongoing free cash flow generation. Industry data also points to strength. According to researcher International Data Corp., the external disk storage systems market grew 4.7% during 2004, aided by strength in the entry level and mid-range market segments.
S&P expects shipments of storage capacity to grow notably over the next several years, driven by the expansion of consumer-electronic devices, e-mail, and the Internet. Sales of hard and CD/DVD-ROM optical disk drives are tied to shipments of PCs, in which they are primarily installed. Stice sees favorable long-term trends, including increased unit shipments of higher capacity drives, manufacturing cost cuts, and more sales of wider margin software products (which in some cases account for 20% or more of current revenue totals). He also anticipates moderate growth in the tape-drive storage market, due to its relatively lower cost and the improving product functionality that we see.
POSITIVE MOMENTUM. As for another key component of the group, Stice sees the printer market being negatively influenced by what S&P sees as the lower priority being placed on it by IT managers, which in turn, is affecting demand and exacerbating pricing pressures. However, Stice expects the sector to improve in coming quarters, due to his view of a reviving global economy and renewed interest in color and digital product lines. The printer market consists of the non-impact segment, including laser, inkjet, and thermal printers, and what we view as a declining market for traditional impact printers.
So there you have it. The subindustry's fundamental outlook and current momentum are in agreement, in S&P's opinion, pointing to likely future advances in share prices. Besides EMC, Stice's top picks among the stocks he covers are Emulex (ELX
; $18), QLogic (QLGC
; $33), Seagate Technology (STX
; $21), Storage Technology (STK
; $32), and Western Digital (WDC
; $15), each of which is ranked 4 STARS (buy).
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), and their proxies (the highest STARS-ranked companies in the sub-industry index -- tie goes to the largest market value) as of May 20, 2005.
S&P High Momentum Portfolio -- 5/20/05
S&P STARS Rank
Construction & Engineering
Fertilizers & Agr. Chem.
Managed Health Care
Oil & Gas Drilling
Oil & Gas E&P
Oil & Gas Refg. & Mktg.
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations and 12.5% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations and 20.3% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations and 17.7% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations and 13.8% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
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Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations. Stovall is chief investment strategist for Standard & Poor's