Information Technology Finance 724/824 SIM Class Summer 2009

Information Technology

Finance 724/824SIM Class

Summer 2009Russell Kolmin

Zachary McAllisterPaul Melko

Mahavir SanghaviDaniel Schuerman

Agenda• Sector Overview• Business Analysis• Economic Analysis• Financial Evaluation• Valuation• Recommendation

Agenda

SIM Portfolio Composition

SIM Portfolio CompositionS&P 500 Weight

SIM Weight +/-

Consumer Discretionary 8.97% 7.50% -1.46%Consumer Staples 12.32% 12.36% 0.04%Energy 12.05% 10.68% -1.37%Financials 13.70% 9.33% -4.37%Health Care 14.06% 13.58% -0.49%Industrials 9.79% 11.57% 1.78%Information Technology 18.43% 20.19% 1.76%Materials 3.20% 4.12% 0.92%Telecommunication Services 3.39% 3.28% -0.11%Utilities 4.10% 3.87% -0.23%Cash 0.00% 3.53% 3.53%

SIM Weightings Relative S&P 500

SIM Weighting Relative S&P

Sector OverviewDescription Total number of

CompaniesAdj MktCap (in Miilions) QTD YTD

S&P 500 500  8,587,679  6.52% 8.42%

Energy 40  1,059,652  5.98% 2.55%

Materials 28  290,442  11.80% 25.52%

Industrials 58  841,227  6.35% -1.82%

Consumer Discretionary 81  779,409  8.03% 16.16%

Consumer Staples 41  1,019,872  5.88% 2.24%

Health Care 53  1,188,645  5.71% 4.70%

Financials 79  1,149,074  4.16% -0.80%

Information Technology 76  1,621,022  9.14% 35.42%Telecommunications Services 9  289,992  1.86% -4.99%

Utilities 35  348,343  5.78% 1.47%

Sector Overview Sector  Industry % of S&P500 SIM Holdings

Information Technology Application Software 0.52% Communications Equipment 2.82% Computer Storage/Peripherals 0.60% Computer Hardware 5.04%AAPL

HPQElectronic Components 0.38% Electronic Equipment 0.13% Electronic Manufacturing Services 0.05% Home Entertainment Software 0.08% Internet Software and Services 1.89% IT Consulting and Services 0.10%(NCR)Office Electronics 0.80% Semiconductor Equipment 0.35% Semiconductors 2.35%INTCServices - Data Processing 0.94% Systems Software 3.51%ORCL

MSFT

Sector OverviewTicker Company Market Cap % of S&P 500 % of Info Tech

SectorMSFT Microsoft 208.7 2.43% 12.87%

IBM IBM 154.11 1.79% 9.51%

AAPL Apple 143.31 1.67% 8.84%

GOOG Google 141.12 1.64% 8.71%

CSCO Cisco 126.2 1.47% 7.79%

ORCL Oracle 111.81 1.30% 6.90%

INTC Intel 108.32 1.26% 6.68%

HPQ Hewlett Packard 99.55 1.16% 6.14%

QCOM Qualcomm 78.71 0.92% 4.86%

TXN Texas Instruments 30.39 0.35% 1.87%

Business Analysis-Info Technology

• Largest sector with a focus primarily on computer hardware and software.

• Sector growth depends primarily on technological advancement and innovation.– Unpredictable: what is hot now may be obsolete in 6 months

• Dependence on cutting edge technology leads to enormous R&D costs.– These R&D costs are the largest barrier to entry

Business Analysis (cont.)• Cyclical Sector with large impact on S&P500

– Tends to follow market cycles, can be highly volatile– A leading indicator during recovery, growth periods

• Largely impacted by Corporate and Consumer Spending– Current Corporate/Consumer spending is down, however with

ongoing technological advancements, corporations will be upgrading IT as recovery begins

• Primary indicator is Personal Computer demand– PC Demand tends to create “pin-action” on all other IT

components (i.e. Software, Peripherals, Storage, Services)

• New Trend – Cell phones becoming handheld PCs– Leads to need for PC style software, hardware, storage, etc.

Business Analysis (cont.)• Information Technology Life Cycle – primarily impacted

by the life cycle of PCs– PCs’ typical life-span = 3-5 yrs (physically longer, however obsolete)

• Demand – largely affected by developed countries, growth potential in under-developed– 60% of all PCs owned by 15% of the world-wide population1

• LOTS of untapped demand– Increasing handheld device demand/infrastructure

• Tel-com sector expanding infrastructure and increased cell phone capabilities desired

1: www.garnter.com (June 23, 2008)

Business Analysis (cont.)• Growth OpportunitiesOpportunities

– US Healthcare reform (Electronic Patient records)– Windows 7 (How will it be received?)

• Office 2010– Increased Corporate Spending/ Consumer Saving Rate (following

recovery, where will money be spent?)– Stimulus Package (how will broadband infrastructure expansion impact

demand?)– Asia Growth/Savings Rates (exploding demand?)

• Growth RisksRisks– Regulations (China, Iran, North Korea, etc)– Double-dip recession or unstable recovery

Business Cycle Analysis

Investopedia.com

Business Analysis Summary• IT Growth Opportunities outweigh risks

– However double-dip still possibleHowever double-dip still possible• Demand is Strong Long Term

– IT becoming a business staple with massive growth potential innovation

• Short-term…what happens with Windows7 and Corporate Spending?– It appears IT spending is going to increase

Economic Analysis• Key facts about Info Tech sector

– Over 75% of sales outside the U.S. for almost all major companies.

– Leading Indicators• Global Semiconductor Bookings• Corporate IT Spending Index• Change in Real Consumption (U.S.)

– Consumer Confidence Index is a good gut check.– Data on leading indicators was available only up to June 09,

which limited the predictive power of the analysis in the short term.

Economic Analysis

-2.1

Is the rest of the World GDP lagging US GDP?

Economic Analysis

323.4

Economic Analysis

Economic Analysis

-73.7

Economic Analysis

49.3

Economic Analysis Summary• Leading Indicators show that the sector may be

overvalued based on the comparative analysis.• If the assumption that ROW is going into a recession

holds true then IT sector will be hurt. • In the short term,

– With a slowly recovering global economy, this sector may be a drag with no significant upside.

– With the possibility of a double dip recession in the U.S. and slowing global economy, the sector has a significant downside.

• In the long run,– The sector is more attractive at a reasonable valuation.

Financial AnalysisIT Sector Index over the past five years

Index price relative to S&P 500

•The IT Index has been lagging relative to the S&P 500 the past couple years – recovering from tech bubble•However this has changed so far this year, with the Index well outpacing the S&P 500 – will it continue?

High: 12.3Low: -19.4Current: 12.3

EPS Analysis•Year to year EPS increased until 2009•This latest year is the first one that saw a decrease in EPS for the last five year.

High: 20.46Low: 10.24Median:16.41Current: 17.71

Net Profit Relative to S&P 500•Profit has consistently been higher than the S&P 500 average•Over the past couple of years this difference has jumped even higher

IT Sector Return on Equity

High: 22.5%Low: 16.7%Median: 19.5%Current: 21.7%

•Has risen rather consistently over the past 5 year, with only a slight decrease this year 

ROE Relative to S&P 500•The IT sector ROE has been relatively close to S&P 500 average, however this has changed since 2007

Financial Evaluation Summary• Even though the IT sector has gone down in

EPS, ROE and Net Profit Margins, it has still out performed the S&P 500 in these areas

• This outperformance is probably why the IT sector has gone up in price more than any other sector in the S&P 500 this year

• Have prices caught up with this performance, or will they continue to outpace the S&P 500?

High 1.4Low .98Median 1.3Current 1.1

Relative Price/Earnings

High 1.7Low 1.2Median 1.4Current 1.7

Relative Price/Book

High 2.1Low 1.5Median 1.7Current 2.1

Relative Price/Sales

Relative Price/Cash Flows

High 1.6Low 1.1Median 1.4Current 1.3

Absolute Basis High Low Median CurrentP/Trailing E 31.5 11.1 22.3 17.2

P/Forward E 23.9 12.1 20.3 17.5

P/B 4.8 2.3 3.9 3.5

P/S 3.0 1.3 2.5 1.9

P/CF 17.7 8.0 14.5 11.3

Relative to SP500 High Low Median Current

P/Trailing E 1.6 .91 1.3 1.1

P/Forward E 1.4 .98 1.3 1.1

P/B 1.7 1.2 1.4 1.7

P/S 2.1 1.5 1.7 2.1

P/CF 1.6 1.1 1.4 1.3

Sector Valuation Summary

Valuation Summary• On an absolute basis, the sector is

inexpensive.• Relative to the S&P500, the sector is a

little expensive.• The direction of the market will determine

the sector’s future.

Recommendation• Currently over-weighted in the SIM (1.76%)

– Almost same as Industrials• Best performing sector in the S&P for the year• Will performance continue?• Yes, world-wide growth will drive IT growth• Yes, recovery will drive IT spending• Yes, long-term growth of IT seems inevitable• Yes, IT is becoming a business staple• Yes, near-term IT spending is trending up• No, economic analysis reveals that the sector may be overvalued.• No, short-term run is ending based on P/S (which is above its median)• Recommend weighting stands where it is.

Appendix

EPS Growth Relative to S&P 500

•IT Sector can have widely fluctuating EPS growth relative to the S&P 500

Net Profit Margin in IT Sector

•Saw large increase in 2007, however fell back down in 2008 and into 2009

High: 12.2%Low: 11.0%Median: 11.3%Current: 11.3%

Holdings Valuation Analysis

Stock AAPL HPQ INTC MSFT NCR ORCL

P/Forward EMedian

28.530.1

10.714.4

20.318.8

15.318.0

21.510.2

14.516.3

P/SMedian

3.75.2

0.81.0

3.23.4

5.16.4

0.50.6

4.75.6

P/BMedian

5.86.5

2.52.4

2.83.4

6.26.0

4.91.9

4.45.9

P/EBITDAMedian

19.3327.52

6.7111.2

10.459.54

9.1215.21

4.375.61

8.7414.03

P/CFMedian

26.134.6

7.611.2

12.811.6

11.818.0

5.46.7

12.116.3

Holdings Valuation Analysis

Stock AAPL HPQ INTC MSFT NCR ORCL

P/Forward EMedian

28.530.1

10.714.4

20.318.8

15.318.0

21.510.2

14.516.3

P/SMedian

3.75.2

0.81.0

3.23.4

5.16.4

0.50.6

4.75.6

P/BMedian

5.86.5

2.52.4

2.83.4

6.26.0

4.91.9

4.45.9

P/EBITDAMedian

19.3327.52

6.7111.2

10.459.54

9.1215.21

4.375.61

8.7414.03

P/CFMedian

26.134.6

7.611.2

12.811.6

11.818.0

5.46.7

12.116.3

Economic Analysis

Economic Analysis

Economic Analysis

Economic Analysis

-1.8

Absolute Forward Price/Earnings

High 23.9Low 12.1Median 20.3Current 18.0

Absolute Price/Book

High 4.8Low 2.3Median 3.9Current 3.6

Absolute Price/Sales

High 3.0Low 1.3Median 2.5Current 2.0

Absolute Price/Cash Flow

High 17.7Low 8.0Median 14.5Current 11.7