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Old Tech Firms: The New Bonds

A trio of “old tech” companies reported quarterly earnings this week, which in the past would have drew yawns from stock market analysts. But with overseas investors fleeing the uncertainty of Europe and Asia for the relative security of the United States, many of these stocks have become de facto bonds given their huge cash flow, dependable dividends and modest valuations.

Those measures are the three that make up my IDEAL stock rating system, which I use to identify safe growth plays in an otherwise treacherous market.

Let’s look at those companies:

International Business Machines (IBM) got the party started on Monday, when it announced second quarter earnings of $2.95 per share versus $2.89 expected by analysts. The company also beat on its revenue forecast, coming in at $20.24 billion compared to $20.03 billion. To be clear, revenue is still generally declining and profitability is less than what it has been, but in terms of moving towards its new identity as a cloud and data business, IBM is ahead of schedule. Shares of IBM bounced slightly higher on this news, after having already appreciated more than 15% this year.

Tuesday it was Microsoft’s (MSFT) turn to release its quarterly results, and the news was better than expected, driving its share price up more than 6% the next day.  The cloud is where the action is in tech these days, and Microsoft appears to be successfully moving in that direction. MSFT has gained more than 35% since dropping to $40 last August, and its recent share price of $56 finally put it back into positive territory for this year.

By the time Qualcomm (QCOM) reported its earnings on Wednesday the market was primed for more good news, and the company did not disappoint. In fact, QCOM surprised an already optimistic market by beating its earnings estimate by nearly 20%, reporting an adjusted figure of $1.16 per share versus an expected $0.97. That news catapulted its share price 10% higher, breaking above $60 for the first time since last November and marking a 20% rise since the beginning of this year.

Those three companies, along with Apple (AAPL) and Xerox (XRX), comprise the ‘Information Technology’ sleeve of the Personal Finance Growth Portfolio. And with Apple and Xerox scheduled to release their earnings reports next week, you can be sure that a lot of eager investors will be watching to see if the news is equally good on the earnings front. The reason for so much interest in these stocks is simple: all five of them pay a dividend ranging between 2.2% to 3.6%, which on average is about double the 1.5% yield on the 10-year Treasury note.

Just as importantly, those dividends are paid in U.S. dollars, which enjoy strong purchasing power everywhere in the world these days. Foreign investors crave investment returns outside their own countries due to the low (and in some cases, negative) interest rates on their own government debt, and large American companies with healthy balance sheets are increasingly viewed as a safe alternative to bonds.

But with so many industries to choose from, why is “old tech” emerging as the equity market of choice for many investors? It boils down to cash. In addition to their sizable dividends, almost all of those companies are sitting on so much money that they can also buy back large amounts of their own stock to keep the share price stabilized (and earning per share, the metric used to measure the management team’s bonuses, on the rise). 

The thinking among professional portfolio managers is that if there is not going to be much growth in the economy, owning cash-rich companies that can return capital to shareholders in the form of dividends and stock repurchases is the next best game in town.

And while there are many companies in other sectors also sitting on impressive cash hordes, technology firms have pricing power that few other businesses can claim given how essential it is in the current economy. Utilities enjoy the same position, which explains why essential service utility stocks have performed so well recently, and also why certain indispensable healthcare stocks, such as Johnson & Johnson (JNJ), are at all-time highs.

So don’t be surprised if the rest of this year, or at least through our election in November, becomes an exercise in capital flowing into the biggest and richest American companies at the expense of smaller and less liquid ones.

 And if you want to know who they are, visit the S&P 500 Data Table at the Personal Finance website to see which ones are still worth buying, and which ones you should avoid.


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