Small-Cap Tech May Lure Investors Bullish on Growth

The investment outlook for small-cap technology companies is improving as cheap valuations and conservative earnings estimates make them more attractive, after being weighed down by concerns about the economy. Small-cap businesses are expanding to provide additional products and services — including the delivery of storage, software and other computing tasks over the Internet “cloud.” This is boosting sales, as valuations and estimates for 2012 earnings remain moderate, said Steven DeSanctis, head of U.S. small-cap strategy at Bank of America Merrill Lynch Global Research in New York. With cash-flush balance sheets that account for about 20 percent of their market capitalization, tech stocks are poised for “pretty good” growth after last year’s “laggard performance,” he said. The cash hoard is attracting investors because companies may use it to pay dividends, repurchase stock or make acquisitions, he added. The Russell 2000 Technology Index — currently made up of 292 businesses with market cap of less than $3.45 billion — has risen 21 percent since Sept. 6, 2011, compared with a 20 percent gain for the Russell 2000. This follows almost seven months of underperformance, when the tech stocks lagged behind the Russell 2000 by 8.9 percent. The tech index has been held back by investor worries about global growth, according to Lawrence Creatura, who helps oversee $363.6 billion as a fund manager in Rochester, New York, at Federated Investors Inc.

Investor Opportunity

“While this sector has enjoyed strong earnings, it hasn’t enjoyed robust price appreciation so far this year,” Creatura said. “Within that may lie an opportunity for investors,” because these companies benefit from strong balance sheets and better valuations than other industries, he said. Small-cap tech stocks have “moved sideways” relative to the Russell 2000 during the past eight months, reflecting a lack of market interest, said Jim Stellakis, founder and director of research at New York-based research company Technical Alpha. The tech index is holding at a so-called triple bottom on a weekly relative basis: when stocks reach a particular level three times without trading below it. That’s bullish, indicating buyers still are willing to invest at the same lows reached in September and January, he said. If the group were to trade below this level, it would signal that sentiment has become more pessimistic, he added. These companies are very sensitive to the economy, and “during times of fear and uncertainty, investors don’t rush to buy,” Creatura said.

Slower Growth

The U.S. expanded at a less-than-forecast 2.2 percent annual rate in the first quarter after a 3 percent rise in October-December, data from the Commerce Department show. The median forecast of economists surveyed by Bloomberg News called for 2.5 percent growth. While demand for Unisys Corp. (UIS)’s system and security services remains “difficult,” the Blue Bell, Pennsylvania- based company is “not necessarily controlled by those macro trends,” Chairman and Chief Executive Officer Edward Coleman said on an April 24 conference call. He is “encouraged” by customer interest, with orders for services growing at a double- digit rate through the second consecutive quarter, he said. The tech companies are attractive because their valuations are historically cheap and 2012 earnings estimates are lower than those for the Russell 2000, even as the U.S. expansion has slowed, DeSanctis said. The group is trading at a premium of about 17 percent relative to all small caps on a price-to- earnings ratio, compared …..

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