Looking For A New Angle On Tech? Two Midcaps

The Leuthold Group, which uses a mix of fundamental growth and valuation screens overlaid with technical analysis, continues to find the best opportunities in technology. Its U.S. Select Industries portfolio has 28% invested in the sector, 10 percentage points more than the sector’s weighting in the S&P 500, and up from Leuthold’s 11% bet a year ago. Through October, the portfolio was up 32% compared to the 25% gain for the S&P 500.

Five of the 15 tech groups Leuthold tracks are currently rated attractive, and in the portfolio. The data processing group is the single largest industry weight at 10%. It’s been in the portfolio for the past two years, and was added to last month.

In October, the only new group to land in the portfolio was yet another slice of the tech world. Technology Distributors now account for 4% of the overall portfolio. For investors who get the tech value proposition but don’t need yet another money manager making a pitch for unloved behemoths such as Apple (AAPL), Microsoft (MSFT) and Intel (INTC), Leuthold’s tech distributor theme is a singularly midcap and small cap affair.

Two mid-caps among the 12 tech distributors now in the portfolio are Arrow Electronics (ARW) and Avnet (AVT). Both companies basically work the parts and services supply chain for OEM and other industrial clients.

If you thought Apple and Microsoft were cheap, these two distributors re-set the bar:

ARW PE Ratio (Forward 1y) Chart

ARW PE Ratio (Forward 1y) data by YCharts

Profitability treading water the past few years explains that valuation:

ARW EPS Diluted (TTM) Chart

ARW EPS Diluted (TTM) data by YCharts

So what’s the catalyst out of that holding pattern? Leuthold makes a familiar demand-side argument for the group: Capex spending by end users has been lackluster of late, but that is likely to (finally) pick up next year amid improving economic factors that should get corporate wallets to open a bit wider. Leuthold references the 6% tech spending uptick Forrester Research forecasts for 2014, up from this year’s expected 4% rise.

Despite their relatively small market caps, Leuthold’s Kristen Henderson points out that the distributor group works on a global stage; more than half of the group derive at least 30% of revenue from outside the U.S. Arrow Electronics sells to more than 100,000 OEMs in 55 countries. About half of its $20.4 billion in sales last year came from outside the U.S. Avnet operates in more than 80 countries. For fiscal 2013 (through June) Avnet reported 42% of its $25.5 billion revenue was from international operations. If that tech- spend meme does play out in 2014, these cheap mid-stream suppliers could indeed see profitability finally trend up.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.



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