Part 4: Converting BiQ Scores to Buy and Sell Recommendations
Last week we explained how we calculate the Boeckl Innogration Quotient, or “BiQ”, for a tech company based on the three components of our formula. To summarize, we assign a numerical value for each component based on dividend yield, growth in cash flow, and strategic direction. Those three values are added together to determine the extent to which a company will be able to “innograte”, or invest in innovation and integration to develop a market leading product.
Generally speaking, companies with the highest BiQ scores are already market leaders as the result of past success which is creating the healthy cash flow that enables them to pay a meaningful dividend. In addition, they are executing an innogration strategy that should make it very difficult for a competitor to surpass them with a superior product.
However, a high BiQ score alone does not necessarily mean that a company is a good investment. Many popular tech stocks are currently trading at prices so high that only the slightest disruption could send them into a tailspin. Conversely, other tech stocks currently out of favor are trading at valuations so low that even a slight improvement in their outlook could result in substantial appreciation. Therefore, the BiQ score for a company must be adjusted up or down to reflect the extent to which its stock is currently trading above or below market averages.
Introducing the Smart Tech Rating
In order to adjust for relative stock market valuation we have created a second metric we call the Smart Tech Rating, or STR. To determine the STR for a stock we compare its estimated future twelve months, or “forward”, earnings against that same metric for its sector, and then multiply that ratio times the BiQ. For example, if a company has BiQ of 5.0 and its forwards earnings multiple of 40 is twice its sector average of 20, then its BiQ score is reduced by 50% (i.e., 20/40) for an STR of 2.5.
You may recall last week we used Amazon (NasdaqGS: AMZN) as an example of a company that has a fairly average BiQ score of 4.2 (on a scale of 0 – 10). However, its stock is currently trading at more than 150 times future earnings, compared to 23 for its peer group. Therefore, its BiQ score of 4.2 is multiplied by .15 (23/150) for an STR of only 0.64. Not only does this make Amazon not a ‘buy’, but it makes it one of the most overvalued tech stocks in our entire coverage universe. It may continue to rise, but the potential rewards simply aren’t worth the risk.
By comparison, Oracle (NYSE: ORCL) has a BiQ score of 4.1, virtually identical to that of Amazon. However, Oracle is trading at a forward earnings multiple substantially less than its peer group (12 versus 25), so it’s BiQ score is doubled for an STR of 8.2. Not only does that make Oracle a ‘buy’, but places it among the top ten tech stocks to own right now.
Using the STR to Manage Your Portfolio
So now that we can calculate the STR for each company, there are several ways we can use this information to make intelligent portfolio decisions. First, as shown in the example above, it can identify stocks that are currently so far overvalued or undervalued that immediate action should be taken. Second, it can also be used to set buy limit prices for stocks you don’t currently own, and sell limit prices for ones you do own.
Not only can we use the STR to determine an absolute value for a company, but we can also use the average STR for all 50 of the tech stocks we cover to determine the relative value of an individual company. In order to do so we calculate the STR for each company and then add them together, the sum of which we call the Boeckl-Pearce Technology Index, or BPTi. We then divide the BPTi by the number of stocks to determine the average STR for the entire index.
We believe that any stock trading at a 50% premium (or greater) to the average STR is most likely a ‘buy’, and any trading at a 50% discount (or greater) is probably a ‘sell’ (of course, we look at the circumstances contributing to these outliers to account for any unique events or extraordinary circumstances that might offset rendering a recommendation based on its score). Those stocks that remain in the upper and lower echelons of our STR scores after that process are where we look for current investment opportunities, as they represent the greatest potential gain with the least amount of risk.
Next Issue: Profiting from “The Utility Stocks of the Future”