Blue-chip tech stocks on rare double-digit discounts

The market rodeo over the past few weeks has been making many an investor’s stomach turn. As Beijing digs in its heels deeper on trade against Trump, escalating the game of chicken with more ominous threats of hitting the U.S. where it hurts most, there appears to be no end in sight of the trade war and, resultantly, of the stock market volatility.

The tech sector makes up a quarter of the market cap of the S&P 500 and any volatility in the sector triggers a cascading effect on wider markets. The sector’s recent wild ride is clearly evident in the Morningstar U.S. Technology Index which has fallen nearly 10% month-to-date (expressed in U.S. dollars) and in the more than 8% loss for the S&P Technology Select Sector Index for the same period, as of May 31.

For patient and prude investors, though, this market slide represents an opportunity to scour the tech sector for mispriced blue chips companies. The largely sentiment-driven sell-off has created attractive entry points for some tech heavyweights that have shed 4% to 16% of their valuation. Long-term investors looking to add or bulk up their tech positions with high-quality names may want to capitalize on the recent tech rout.

King of the hill in the premium smartphone market, Apple Inc. (AAPL) is one of the world’s most valuable tech brands. Most noted for its crown jewel, the iPhone, the tech behemoth also makes iPads, Apple TV, iPods, iMacs, Apple Watch. In addition, Apple offers a variety of services such as Apple Music, iCloud, AppleCare and Apple Pay, among others.

“Apple’s competitive advantage stems from its ability to package hardware, software, services, and third-party applications into sleek, intuitive, and appealing devices [enabling] the firm to capture a premium on its hardware, unlike most of its peers,” says a Morningstar equity report.

“Apple’s differentiated user experience via iOS coupled with its expertise in both hardware and software design allows the firm to more seamlessly build integrated products,” says Morningstar equity analyst, Abhinav Davuluri, who pegs the stock’s fair value at US$200, noting no other technology firm has comparable expertise in both hardware and software.

Online retail giant, Amazon (AMZN) clocked a mammoth US$233 billion in net sales in 2018 and is the world’s second most valuable company after Microsoft, as of May 31. Online product and digital media content sales accounted for 53% of 2018 revenue, while third-party seller services (18%), Amazon Web Services (11%), Prime membership fees and other subscription-based services (6%), Whole Foods and other retail formats (7%) made up most of the rest.

Not content with being the most disruptive force in retail industry, Amazon continues to find ways to evolve its business model. The company’s robust competitive advantage flows from operational efficiency, a network effect, a rich array of products, technology and a user-friendly interface that have attracted more than 440 million estimated global active users and more than 120 million global Prime members, boosting its cash flow.

Few, if any, traditional retailers can match Amazon’s sustainable competitive, asserts Morningstar sector strategist, R.J. Hottovy, in an equity report. The company “is likely to reshape retail, digital media, enterprise software, and other categories for years to come,” says Hottovy, who recently raised the stock’s fair value from US$2,200 to US$2,300, prompted by rapid growth in advertising and subscription services.

The world’s most valuable company, as of May 31, Microsoft (MSFT) develops and licenses consumer and enterprise software, most notable of which is Windows operating systems. The firm’s three key business segments include productivity and business processes; intelligent cloud; and personal computing.

CEO Satya Nadella has reinvented Microsoft into a cloud leader, currently sitting at a close number two after Amazon’s cloud service. “Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model and embraced the open-source movement,” says a Morningstar equity report, adding that having exited the low-growth, low-margin mobile handset business and pivoting to cloud, Microsoft has become “a more focused company that offers impressive revenue growth with high and expanding margins.” Morningstar equity analyst, Dan Romanoff recently raised the stock’s fair value estimate form to US$125 to US$143, based on revenue growth and margin expansion.

Parent company of internet media giant Google, Alphabet (GOOG) generates 99% of revenue from the search engine, of which more than 85% is from online ads. The firm’s other revenue streams include sales of apps and content on Google Play, YouTube, as well as smartphones, smart home products and cloud service fees.

Alphabet dominates the online search market with a global share above 80%, driving strong revenue growth and cash flow. Google is forecast by a Morningstar report to continue to “maintain its leadership in the search market [with] YouTube gradually contributing more to the firm’s top and bottom lines.”

The tech titan’s sustainable competitive advantage flows from technological expertise in search algorithms and machine learning, colossal user data, and the network effect, derived mainly through search, Android, Maps, Gmail, and YouTube.

These moat sources drive growth in the size and overall usage of its products and services. “Google’s ecosystem strengthens as its products are adopted by more users, making its online advertising services more attractive to advertisers and publishers and resulting in increased online ad revenue,” says Morningstar equity analyst, Ali Mogharabi, who puts the stock’s fair value at US$1,300.

Editor’s note: The author owns a small position in shares of Apple and Microsoft.