Just when people were starting to wonder if tech stocks could go much higher, they proved that they could – and with a vengeance. Last week was every tech stock investor’s dream, with a wide variety of companies benefiting from euphoria over better than expected earnings reports from Amazon.com (up 15%), Microsoft (plus 10%), and Google (gaining 4%, despite posting mixed results) just on Friday alone.

As a result, the tech-heavy NASDAQ Composite Index has exceeded its record high from fifteen years ago, topping out above the 5,100 level. As we have stated previously, the difference this time is that the tech sector has become immensely profitable, to the point of becoming almost as reliable as utility stocks when it comes to generating steady profits and paying out big dividends.

Our portfolios did not miss out on the fun last week. Our large-cap Investments Portfolio gained an average of 3.71% compared to an increase of 3.25% in the NASDAQ Composite Index. More impressively, Rob DeFrancesco’s mid-cap Next Wave portfolio racked up a gain of 5.89%, led by Gigamon’s huge 29.35% jump!

With Apple reporting this week – and its stock surging $5 in value in the days leading up to its announcement – the perception of tech stocks has changed notably. The guarded pessimism as to whether these companies can continue to deliver exceptional results despite a strong U.S. dollar (which is devaluing their overseas income) has quickly changed to one of cautious optimism that nothing can derail their market dominance.

It remains to be seen if the good feelings will continue this week, but for now the tech sector has reclaimed its spot at the top of the investment pyramid.

NASDAQ Composite Index:                                                                       

Friday, April 24 = 5,092.08                                                    

Trailing 12 months = + 24.3%                                        

Trailing 7 Days = + 3.2%                                       

Trailing 4 Weeks = + 4.2%                

Investments Portfolio Update – Qualcomm and Verizon

By Linda McDonough

We’re right in the heart of earnings season, with a flurry of news to discuss.  In this issue we review Qualcomm and Verizon’s earnings.  Both are tied to mobile communication trends and should benefit from consumers demanding more functionality from their smart phones.  Heavyweights Intel and Microsoft also reported and pleased the market with strong results.  Microsoft in particular saw its stock race forward 10% as investors cheered the success of the company’s cloud based service.  We’ll cover these two names in more detail in our next issue.

QUALCOMM

Qualcomm reported second quarter earnings on April 22nd. Profits of $1.40 beat estimates by 7c with revenue slightly higher than expected. For the second quarter in a row management guided annual estimates down.  Estimates for the fiscal year (ending September) started the year at $5.20 but were cut to $4.95 in January and then to $4.80 on this most recent earnings release. These cuts seem to be built into investor sentiment as the stock dropped slightly, but then stabilized quickly.

Chinese competition is hurting Qualcomm on two fronts.  Lower pricing on handsets worldwide is forcing many of Qualcomm’s customers to search for ways to lower their cost structure.  Lower priced chipsets from Chinese manufacturers are being used more frequently. Other customers like Samsung have internally designed their own chipset, which they will use instead of Qualcomm’s in some models.  Investors have been grappling with the chance that Samsung may employ its own chipsets in more handset models going forward, reducing orders for Qualcomm. In addition, lower pricing in China hurts Qualcomm’s royalty stream which is based off of the sales price of phones.  The royalty stream accounts for more than half of Qualcomm’s profits.

Management confirmed that Samsung, its largest customer, is transitioning the Galaxy S6 handset and the Note to chips made internally.  While management expressed confidence that its next generation chip will be designed into next generation handsets, many analysts are skeptical.  This begs the question of whether the bar is set low enough that Qualcomm’s stock can tread water until the next product cycle kicks in.

Despite cash flow growth slowing the past few quarters and even coming in negative in the most recent quarter, the company has almost $17 a share in cash.  Excluding cash, the stock trades for less than 10 times next year’s earnings. This compares to the average multiple of 14 for semiconductor peers. In early March, management announced a buyback of $15 billion worth of stock, $10 billion of which would be executed in the next 12 months.  At current prices, this would shrink Qualcomm’s share base by 13%, which would boost earnings by an equivalent amount.  

The company holds an enviable patent position and is initiating a comprehensive cost review to lower its expense structure.  In addition management has agreed to entertain activist proposals to split the company into two parts, which would boost the stock price.  

The stock is an original member of the Smart Tech Investor Investments Portfolio, added on December 16, 2013 at a closing price of $70.85. Qualcomm remains a buy in the STI Investments Portfolio up to $85 and carries a Smart Tech Rating of 7.7.

VERIZON

Verizon is making great strides in its wireless business. As many in the industry engage in price wars to lure subscribers away from the competition, Verizon has chosen to focus on attracting and maintaining its most profitable customers.  CFO Fran Shammo explains, “We have to be rational and we will not chase every customer”.  This rational thinking and strategic pricing on new wireless plans are boosting Verizon’s profitability.

On April 21st the company reported $1.02 in earnings, 7% better than expected.  Earnings per share were up 21%, a remarkable number for a company in the midst of a hyper competitive pricing market. Churn on wireless customers dropped slightly to 1.03%.  Operating income increased 11%, significantly higher than the 4% increase in revenue.  Free cash flow, a metric that looks at cash after equipment spending, was $4.2 billion up 40% from the year earlier period.

Verizon introduced its no-contract plan named Edge in July 2013.  This plan is cleverly designed to attract tech gurus eager to upgrade to a new device frequently.  These desirable customers typically consume more data and are less price sensitive. The plan allows customers to upgrade to a new device after only 6 months as long as they have paid for at least 75% of the price of the device. Who doesn’t hate being stuck with a dinosaur of a handset while they wait out the 2 year wireless contract for a new one? Management reported that 39% of all wireless customer activations were for the Edge plan in the first quarter, up from 25% in the previous quarter.

Verizon is reaping the benefits of a disciplined strategy that allows less profitable customers to emigrate to competitor’s plans while keeping the best for themselves. 

The stock is an original member of the Smart Tech Investor Investments Portfolio, added on December 16, 2013 at a closing price of $45.65. Verizon remains a buy in the STI Investments Portfolio up to $55 and carries a Smart Tech Rating of 8.5, the second highest rating in our portfolio.