Technical factors as well as fundamentals have driven the rise in TMT stocks, and just as a rising t...
Technical factors as well as fundamentals have driven the rise in TMT stocks, and just as a rising tide lifts all vessels, so companies of varying quality have been awarded exceptional ratings. This lack of discrimination is also visible in the manner in which old economy stocks have been ignored.
The lack of liquidity in many of the newer sectors is being addressed along with a realisation that future cash calls will be an inherent feature of many companies in these areas. This is in contrast to old economy stocks, where a number of commentators have suggested - wrongly, we would argue - that the divergence in share prices across the market will deny old economy companies access to capital for investment and development.
The reality is that most old economy companies have retained profits that have funded, and will continue to fund, the majority of their investment needs. Indeed, the spate of share buy-backs suggests many companies have more than sufficient capital. Aware of the risk of a change in market sentiment, emphasis is accordingly placed on TMT stocks that already generate sufficient revenues to fund development.
This precludes most dot.coms, where current cash burn to fund marketing strategies suggests future calls on shareholders are likely.
We are also seeing increased acquisition activity among TMT stocks. There are grounds for suggesting that some companies are simply buying earnings growth to meet analysts' forecasts.
One should remember the saying that if companies buy lower rated companies, they risk turning themselves into lowly rated companies.
Going hand-in-hand with this process of locking in some, but not all, of the profits gained from TMT stocks, is a renewed willingness to invest selectively in lowly rated value plays. The aim is to focus on companies that have been unjustifiably derated.
Cash generation and potential profit growth are key but not sufficient criteria. In addition, industry consolidation and new management or restructuring are looked for as catalysts to drive relative outperformance within these areas. A good example here is Greene King.
The industry is consolidating, the business is cash generative and earnings growth affords the stock a price/earnings growth ratio well below 1.0.
Sustainable growth is not limited to the TMT sectors and we continually look for opportunities across the market. We are happy holders of fund management groups such as Amvescap which should continue to benefit from the demographic trend to savings.
Logistics and outsourcing are clearly secular stories, and we hold Exel/Ocean Group and Compass Group to gain exposure to these trends.
Tim Rees is director, UK Equities, at Clerical Medical
A question of selectivity
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