Does Value Investing Work in the Technology Sector?

/Does Value Investing Work in the Technology Sector?

Does Value Investing Work in the Technology Sector?

By | 2017-08-18T17:06:06+00:00 May 16th, 2014|Research Insights, Value Investing Research|10 Comments

A recent blog post suggests that value investing in the tech sector is a waste of time.

The article tells a compelling story and argues for 2 points:

  1. Successful tech stock investing is done when the stocks are dear, not when they are cheap.
  2. Tech companies should not get credit for huge piles of cash on their balance sheets.

The author then makes the claim that you can’t make big money in cheap tech stocks and buying cheap tech doesn’t work. We thought the blog post was thought-provoking and it inspired us to conduct a quick empirical analysis to ascertain if there was any truth to the claims.

Do value-investing principles matter in the technology space?

First, a quick description of the study we conduct from 1980-2013.

  • Identify firms above NYSE 20th percentile for market cap that have information to calculate enterprise multiples.
    • In today’s terms, this equates to a universe that looks at stocks with a market capitalization of $790mm and up. 
  • Split firms into deciles based on EBIT/TEV
  • Only example firms with SIC codes related to the high-technology sector
    • 5 HiTec Business Equipment — Computers, Software, and Electronic Equipment
      • 3570-3579
      • 3622-3622 Industrial controls
      • 3660-3692
      • 3694-3699
      • 3810-3839
      • 7370-7372 Services – computer programming and data processing
      • 7373-7373 Computer integrated systems design
      • 7374-7374 Services – computer processing, data prep
      • 7375-7375 Services – information retrieval services
      • 7376-7376 Services – computer facilities management service
      • 7377-7377 Services – computer rental and leasing
      • 7378-7378 Services – computer maintanence and repair
      • 7379-7379 Services – computer related services
      • 7391-7391 Services – R&D labs
      • 8730-8734 Services – research, development, testing labs

What do the results look like?

hitech

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The chart above clearly shows there is a relationship between price paid and future performance. The cheapest decile of tech firms earn 15.25% a year, on average, whereas, the expensive decile tech firms earn 1.89%/year. Certainly seems to refute the argument proposed by the author that value investing doesn’t apply to tech firms… Here are some additional statistics comparing the most expensive decile, the mid-range decile, and the cheap decile.

  • NYSE 20 EW EBIT 10 = equal-weight, annual rebalanced portfolio of cheapest EBIT/TEV tech stocks
  • NYSE 20 EW EBIT 5 = equal-weight, annual rebalanced portfolio of 40-50% EBIT/TEV tech stocks
  • NYSE 20 EW EBIT 1 = equal-weight, annual rebalanced portfolio of most expensive EBIT/TEV tech stocks
stats

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Here are the annual returns for the 4 return streams from 1980 to 2013. You’ll notice some dramatic swings in relative performance around the Internet Bubble!

Microsoft Excel - EBIT_TEV_and_tech_firms_analysis_v01

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.


  • The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
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  • This site provides NO information on our value ETFs or our momentum ETFs. Please refer to this site.

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About the Author:

Wes Gray
After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.
  • bryan

    It’s good to see that value investing appears to work in the tech sector. Did your data include companies that went out of business or delisted between 1980-2013? Thanks

  • yes.

  • Mischa Deeter

    Is there survivor bias?

  • Dan B.

    Does this include NASDAQ listed stocks or only NYSE stocks? thanks

  • Jayjay

    How about doing this comparison: 1) cheap tech stocks vs. 2) high growth tech stocks?

  • what type of growth? past growth? expected growth?

  • No. We deal with this using the following algorithm: http://richardp.bus.usu.edu/research/bmp_delistings.pdf

  • Jayjay

    Expected revenue growth. Would be a proxy for what growth investors generally look for. In your existing study, would also be interesting to see the # of companies in the 10, 5 and 1 deciles per year to see how many companies are driving the results in each year. Interesting study.

  • 1980 they have 13 stocks; 1985 20 stocks; 1990 23 stocks; and so forth. From 1990–> they range form 20-40+ in each decile.

  • holycowrickperryisdumb

    If were to do a more granular analysis on a sector level I wonder if the results would be the same – that is, I suspect there is a difference in “value investing” in hardware vs. software/internet