One of the hallmarks of successful investing is the ability to “listen” to the market.
Amidst volatility or economic uncertainty, the stock market often gives clues as to how investors should respond to changing circumstances.
The recent decline of growth stocks in the technology sector and rotation into value is a perfect example.
In the past month, the S&P 500 has declined around 1%, but the technology-heavy Nasdaq Composite is down over 6%.
The tech sector has experienced a significant move to the downside and investors have rotated into value stocks with strong cash flow and solid fundamentals.
Unfortunately, too many investors will interpret this rotation as evidence that the tech sector must be avoided.
And that would be a mistake…
The move in the Nasdaq isn’t telling investors to avoid tech stocks, but rather to be careful about which tech stocks to hold!
As many economic indicators continue to disappoint and volatility rises, the market is clearly signaling a move into value at the expense of growth.
Indeed, there are some crucial lessons to learn from how certain stocks have performed over the past month.
Yes, you heard me right – I just referred to INTC and CSCO as value stocks. The following chart illustrates my claim:
INTC and CSCO have performed brilliantly, while most tech stocks have been hammered.
Clearly, the market is rewarding investors in these newly found value stocks – let’s call them nouveau value.
And a closer look at the valuation metrics of both companies provides a more complete picture as to why these stocks have held up so well.
As you can see, both stocks have solid cash flow and pay healthy dividends.
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So, let’s take a closer look at each one.
A Semiconductor’s Worth
Intel, the world’s largest chipmaker, boasts a dividend yield that would make many consumer staples companies envious, yet it’s also trading at a whopping discount of 62% to the semiconductor industry average P/E of 36.5.
Intel’s failure to increase its dividend in 2013 is a negative, but in light of its huge cash flow, isn’t a reason to avoid the stock.
Free cash flow (FCF) at Intel for Q4 2013 was $3.1 billion, while its FCF for the trailing 12 months was just over $10 billion.
Intel’s five-year average operating margin is an impressive 27%, which shows that the company still has a competitive advantage
Intel’s new cloud computing solutions and its continuing efforts to leverage its relationship with Apple (AAPL) will enable it to maintain this edge.
Even as Intel stumbled in its move to mobile processing, its ability to generate strong cash flow remains remarkable, and it’s this fact that will continue to attract value-minded investors.
Another company that is no stranger to tremendous cash flow is Cisco.
Routing the Cash Register
While Cisco’s revenue growth has slowed in recent years, its ability to generate cash remains astounding.
Cisco’s FCF for the trailing 12 months was $11.3 billion, and its FCF margin has averaged 22% over the previous three years.
High FCF has been the impetus behind Cisco’s 61% increase in dividend payout over the same time frame.
Like Intel, Cisco has an above-average yield at 3.3%. It also trades with a forward P/E of 11.4x, which is downright cheap for any industry.
Cisco has also announced a strategy to capitalize upon the cloud computing trend, which will further strengthen its cash-generating abilities and support its dividend.
So, based on all of these favorable characteristics, it’s not hard to see why CSCO and INTC have done so well in the past month.
Heed the Market’s Advice
Our success as investors is dependent upon our ability to listen, and the markets are telling investors that valuation, not growth potential, is the most important metric for stock selection right now.
Whether it’s the outperformance of INTC and CSCO, or the fact that the utility sector has experienced meaningful inflows, the market is sending a powerful signal.
It’s certainly possible that this fundamental rotation will continue to play out for the remainder of the year, so it’s especially important for income investors to come to terms with what the market is saying.
Therefore, we should embrace volatility, as it will provide opportunities.
High-growth tech stocks will bounce eventually, but astute investors will use that as a chance to rotate further into nouveau value stocks such as INTC and CSCO.
High-quality, high-yielding stocks are outperforming – disregard this value rotation at your own peril.
Safe (and high-yield) investing,
Richard Robinson, Ph.D.