Greg Price Greg Shaskus Min Shen Matt Sims Chris Stuart Recommendation 100 bps increase in SIM allocation for IT resulting in 227 bps overweight Support: Sector Size and Composition Business Analysis Economic Analysis Financial Analysis Valuation Analysis Sector Overview Largest Weight 16 Industries Highly Cyclical Revenues up 8% last quarter EPS up 56% last quarter Sector Info Tech Financials Health Care Cons Staples Energy Industrials Cons Disc Utilities Materials Telecom Market Cap (Millions) $ 1,966,161 $ 1,742,608 $ 1,223,100 $ 1,167,036 $ 1,148,905 $ 1,122,994 $ 1,100,889 $ 367,268 $ 355,185 $ 288,242 Source: Standard and Poors Estimated 63% increase in earnings this quarter SIM Sector Allocation Currently 127 Basis points overweight S&P 500 Sector Percentage Consumer Discretionary 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -4.00% -5.00% -6.00% Series1 S&P 500 SIM Weight Weight 10.55% 10.44% +/-0.11% Consumer Staples 10.91% 11.71% 0.80% Energy 11.18% 9.76% -1.43% Financials 16.47% 11.41% -5.07% Health Care 11.55% 14.63% 3.07% Industrials 10.76% 13.10% 2.34% Info Tech. 18.91% 20.18% 1.27% Materials 3.45% 1.64% -1.82% Telecom 2.73% 3.70% 0.98% Utilities 3.48% 2.10% -1.38% CD CS Engy. Fin. HC Ind. IT Mat. Tel. Util. -0.11% 0.80% -1.43% -5.07% 3.07% 2.34% 1.27% -1.82% 0.98% -1.38% Industries By Market Cap: Rank Industry 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Systems Software Computer Hardware IT Consulting Internet Software Communications Equipment Semi-conductors Services, Data Computer Storage Electronic Component Office Electronics Application Software Semi-conductor Equipment Electronic Equipment Home Entertainment Soft. Electronic Manufacturing Technology Distribution Market Cap Holdings (billions) $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 185.9 165.3 142.6 113.7 99.5 69.3 31.9 23.6 23.1 13.2 11.4 11.3 9.2 5.8 3.3 2.7 ORCL HPQ, NCR RIMM INTC Industry Performance By revenue growth: Industry Performance By earnings per share growth: Rank Industry 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Semiconductor Equipment IT Consulting Communications Equipment Services, Data Computer Hardware Office Electronics Semiconductors Electronic Manufacturing Internet Software Electronic Component Electronic Equipment Technology Distribution Home Entertainment Soft. Systems Software Application Software Computer Storage Market Cap EPS Holdings EPS est. (billions) (current) $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 11.3 142.6 99.5 RIMM 31.9 165.3 HPQ,NCR 13.2 69.3 INTC 3.3 113.7 23.1 9.2 2.7 5.8 185.9 ORCL 11.4 23.6 589% 350% 70% 69% 49% 48% 45% 39% 28% 21% 7% 7% -6% -12% -17% -41% 221% 173% 111% 313% 104% 80% 100% 7% 31% 19% 5% 65% -12% 8% 158% 114% Industries: Summary Attractive industries: Semiconductor Equipment Data Services IT Consulting Computer Hardware (HPQ, NCR) Semiconductors (INTC) Communications Equipment (RIMM) Industries to Avoid: Home Entertainment Software Systems Software (ORCL) Electronic Equipment Electronic Manufacturing Largest Companies 10 largest companies in S&P 500: Constituent Exxon Mobil Corp Apple Inc. Microsoft Corp General Electric Co Procter & Gamble Johnson & Johnson Bank of America Corp Wells Fargo & Co JP Morgan Chase & Co Intl Business Machines Corp Symbol XOM AAPL MSFT GE PG JNJ BAC WFC JPM IBM Sector Energy Info. Tech. Info. Tech. Industrials Consumer Staples Health Care Financials Financials Financials Info. Tech. Price ($) 65.23 253.99 28.93 18.04 62.42 64.75 17.3 32.97 41.95 126.27 Sector Performance Price Returns by Sector Energy Materials Industrials Cons Disc Cons Staples Health Care Financials Info Tech Telecom Utilities MTD QTD YTD -4.22% -4.13% -2.71% -2.73% -0.26% -1.29% -1.40% -3.05% -1.40% -1.64% 0.02% -3.74% 1.27% 3.13% -1.81% -5.14% -0.12% -1.34% -2.78% 0.75% 0.11% -1.42% 13.88% 13.49% 3.14% -2.40% 10.69% 0.31% -8.28% -3.90% YTD Rank 6 7 1 2 4 8 3 5 10 9 Business Analysis Sector growth depends on Innovation Technological advancement Cost reduction Highly diverse with companies in growth and mature phases Few dominant players in each industry within the sector Dependence on cutting edge technology leads to enormous R&D costs R&D spending is 2.5 times of the automotive industry and more than 3 times of the pharmaceutical industry R&D costs largest barrier to entry Huge threat of substitutes and piracy Business Analysis (cont.) Highly cyclical sector with large impact on SIM Tends to have large growth during market recoveries Can be highly volatile Affected by customer and corporate spending Signals point that both are increasing Intel’s most recent earnings forecast signals a rebound in corporate IT spending The iPad sold over 1 million units in just 28 days Business Analysis (cont.) Growth potential in the smart phone and tablet market Apple, Google, and RIM dominate the market making it difficult for other companies to be successful Increased competition will decrease prices and result in lower margins Growth potential in India, China, and Africa As penetration rates approach 90% in developed regions companies look for new opportunities Business Analysis (cont.) Other growth opportunities Microsoft Office 2010 to be released in June IT Solution Services Risks of W-recession or unstable recovery Last Thursday and Friday was a perfect example Tech stocks were hit hard Many lost all of their gains for the year Business Analysis Summary Long-term IT growth opportunities outweigh risks Demand will continue to increase IT becoming a business staple with massive growth potential Short-term Corporate spending/profits continue to increase GDP growth Stovall’s guide to S&P Sector Rotation Stovall’s Sector Rotation IT generally does well where business is down, unemployment is up, GDP is down, interest rates are falling and consumer expectations are down. Fundamentals of companies can be influenced greatly by the surrounding economy Business Cycle is used to understand the present position of the cycle and to predict what areas of the economy will be stronger in the future. Strategy is to buy into a sector that is about to take off and sell at the peak. Capital Spending V. IT Sector Federal Funds Rate V. IT Sector Velocity of Money V. IT Sector Consumer Confidence V. IT Sector Consumer Spending V. IT Sector Employment V. IT Sector Real GDP V. IT Sector Market Pyramid Railroad: Total International Traffic Revenue (Indexed) 150% 125% 100% EBITDA Margin 30% 1.6 Sector 25% 1.4 1.2 20% 1.0 15% 0.8 0.6 10% Relative to S&P 500 5% 0% 0.4 0.2 0.0 Absolute Relative High 26.5 1.4 Low 21.2 .8 Median 22.2 1.1 Current 26.5 1.4 Net Profit Margin 14% 2.0 Relative to S&P 500 1.8 13% 1.6 13% 1.4 12% 1.2 1.0 12% Sector 11% 11% 10% 0.8 0.6 0.4 0.2 0.0 Absolute Relative High 12.9 1.9 Low 11.3 1.2 Median 11.8 1.4 Current 12.9 1.9 EPS Growth (yr over yr) 60% 50% 40% Sector 30% 20% 10% 0% -10% -20% Relative to S&P 500 -30% (%) Absolute Relative High 47.8 35.5 Low -18.2 -33.9 Median 16.0 - Current .4 5.3 Return on Equity 25% 2.0 1.8 20% 15% 1.6 Sector 1.4 10% Relative to S&P 500 5% 0% 1.2 1.0 0.8 Absolute Relative High 23.5 1.8 Low 18.7 .9 Median 19.5 1.3 Current 23.5 1.6 Financial Analysis Strong overall performance Growth potential within sector EPS projections Sector rotation Sector Valuation: Info Tech (22 years) Absolute Basis High Low Median Current P/Trailing E 74.6 11.1 26.1 18.9 P/Forward E 64.7 12.1 22.5 14.4 P/B 15.1 2.3 4.1 3.7 P/S 6.7 0.8 2.5 2.4 P/CF 45.8 8.2 16.0 12.1 Green= Cheap Red= Expensive Sector Valuation: Info Tech (22 years) Relative to SP 500 High Low Median Current P/Trailing E 2.6 0.91 1.4 1.1 P/Forward E 2.7 0.98 1.3 1.0 P/B 3.0 0.9 1.4 1.7 P/S 3.0 0.9 1.7 2.0 P/CF 2.6 1.1 1.5 1.3 Green= Cheap Red= Expensive Sector Valuation: Info Tech (5 years) Absolute Basis High Low Median Current P/Trailing E 25.0 11.1 20.8 18.9 P/Forward E 22.4 12.1 18.9 14.4 P/B 4.8 2.3 3.9 3.7 P/S 3.0 1.3 2.5 2.4 P/CF 17.7 8.2 14.1 12.1 Green= Cheap Red= Expensive Sector Valuation: Info Tech (5 years) Relative to SP 500 High Low Median Current P/Trailing E 1.5 0.91 1.2 1.1 P/Forward E 1.4 0.98 1.3 1.0 P/B 1.8 1.2 1.5 1.7 P/S 2.1 1.5 1.7 2.0 P/CF 1.6 1.1 1.3 1.3 Green= Cheap Red= Expensive Industry Valuation: Computer Hardware (HPQ, NCR) Absolute Basis High Low Median Current P/Trailing E 95.1 10.4 21.9 17.0 P/Forward E 45.6 10.8 19.5 14.9 P/B 11.2 1.0 3.9 5.0 P/S 3.3 0.4 1.3 1.7 P/CF 29.2 7.1 13.6 11.2 Green= Cheap Red= Expensive Industry Valuation: Computer Hardware (HPQ, NCR) Relative to SP500 High Low Median Current P/Trailing E 5.7 0.75 1.2 0.98 P/Forward E 1.9 0.81 1.2 1.0 P/B 2.5 0.4 1.3 2.4 P/S 1.5 0.5 1.0 1.4 P/CF 1.7 0.8 1.2 1.2 Green= Cheap Red= Expensive Industry Valuation: Semiconductor (INTC) Absolute Basis High Low Median Current P/Trailing E 135.8 11.6 23.5 26.4 P/Forward E 422.1 11.9 24.1 11.9 P/B 13.8 1.6 3.6 3.0 P/S 13.0 0.7 3.3 3.0 P/CF 37.3 6.4 14.3 9.9 Green= Cheap Red= Expensive Industry Valuation: Semiconductor (INTC) Relative to SP500 High Low Median Current P/Trailing E 5.6 0.74 1.4 1.5 P/Forward E 34.7 0.60 1.4 0.84 P/B 2.6 0.8 1.3 1.4 P/S 5.8 0.9 2.4 2.5 P/CF 2.4 0.9 1.3 1.0 Green= Cheap Red= Expensive Industry Valuation: Systems Software (ORCL) Absolute Basis High Low Median Current P/Trailing E 75.6 9.4 26.9 15.3 P/Forward E 35.1 9.8 19.7 14.3 P/B 26.6 3.0 5.8 4.6 P/S 21.8 2.2 7.8 3.6 P/CF 65.6 8.2 19.2 12.1 Green= Cheap Red= Expensive Industry Valuation: Systems Software (ORCL) Relative to SP500 High Low Median Current P/Trailing E 2.5 0.83 1.4 0.88 P/Forward E 1.7 0.78 1.2 1.0 P/B 5.5 1.3 2.2 2.2 P/S 9.7 2.8 5.6 3.0 P/CF 3.7 1.0 1.8 1.3 Green= Cheap Red= Expensive Industry Valuation: Communications Equipment (RIMM) Absolute Basis High Low Median Current P/Trailing E 211.9 11.0 25.4 20.9 P/Forward E 475.1 12.1 22.4 16.8 P/B 12.1 1.0 4.3 3.0 P/S 5.1 0.7 2.1 3.2 P/CF 55.5 8.8 17.6 14.5 Green= Cheap Red= Expensive Industry Valuation: Communications Equipment (RIMM) Relative to SP500 High Low Median Current P/Trailing E 10.1 0.91 1.4 1.2 P/Forward E 29.1 1.0 1.4 1.2 P/B 2.4 0.3 1.4 1.4 P/S 3.0 0.7 1.6 2.7 P/CF 3.2 0.8 1.6 1.5 Green= Cheap Red= Expensive Conclusions Based on Valuation: • Sector as a whole and most industries within are currently undervalued; • Economy likely to pick up, upside potential in this sector. Recommendation 100 bps increase in weight to 227 bps overweight Top-line growth prospects: Office electronics, Data Services, Electronic Equipment, Semiconductor Equipment industries Current phase of business cycle favors investment in the IT sector Sector as a whole and the industries are currently undervalued