Four tech stocks to upgrade investment returns

Though the sector has done well lately, the four stocks below are rated 4-stars based on their current discount to our analysts' estimates of their fair value.

Canada-based independent IT services provider  CGI Group (GIB.A) generates more than $10 billion in annual revenue operating in 40 countries. The firm's largest markets are North America and Europe where it offers a range of services including consulting, systems integration, application maintenance and business process outsourcing. The firm derives about 33% of its revenue from government contracts.

Morningstar research attributes CGI's rise to prominence to its active pursuit of mergers and acquisitions. The company has made 70 acquisitions, including high-profile deals such as American Management Systems, Stanley and Logica. Based on 2015 third-quarter results, Morningstar equity analyst Andrew Lange has placed the stock's fair value at $55, which assumes a forward fiscal-year price/earnings ratio of 18 times, and a 7% free cash flow yield.

"We assume a mix of organic and inorganic growth to drive a 3.9% revenue compound annual growth rate over the next five years given CGI's build-and-buy growth strategy," says Lange, noting that the company's deep IT knowledge and entrenched position in North America and Europe make it "an attractive partner for clients mired in IT complexity." The often mission-critical nature of work performed by CGI makes for sticky client relationships, which benefits the firm, in addition to high switching costs.

Chipmaker  Qualcomm Inc. (QCOM) is known for its Snapdragon processor used in high-end smartphones and other digital devices. Apart from making software and chips for clients including Samsung and Apple, the firm also has a highly profitable licensing business.

The Morningstar analyst report on the stock says the company's significant intellectual property assets allow it a wide economic moat, or competitive advantage. "It holds a near monopoly on essential patents used in CDMA technology, a major wireless communications standard that enables mobile devices to send and receive voice signals and wireless data," says Brian Colello, an equity analyst at Morningstar. "As all 3G wireless networks are based on CDMA technology, and the vast majority of 4G phones will be backward compatible with 3G, Qualcomm will probably be able to reap royalty fees on a substantial majority of smartphones sold over the next decade or two."

Qualcomm is also big on distributing cash to shareholders. The company bought back US$4.55 billion of stock in fiscal 2014 and US$9.5 billion more so far in fiscal 2015, with US$8.6 billion in stock buyback authorization still outstanding. Qualcomm also pays out a solid quarterly dividend of US$0.48 per share, offering a solid yield north of 3%--a rarity in the semiconductor industry. The stock is nearly 30% cheaper than its January 2015 peak price.

Regarded as one of the world's most valuable tech brands,  Apple Inc. (AAPL) makes digital devices that are sought and sold globally. The US$170-billion behemoth makes consumer electronics devices including tablets (iPad), digital media player (Apple TV), portable music player (iPod), personal computers (Mac), smartwatches (Apple Watch) and, most notably, premium smartphones (iPhone).

"Apple's strength lies in its experience and expertise in integrating hardware, software, services and third-party applications into differentiated devices that allow Apple to capture a premium on hardware sales," says Morningstar equity analyst Brian Colello, who puts the stock's fair value estimate at US$140.

Apple's competitive advantage, he adds, lies in "switching costs related to many attributes around the iOS platform that may make current iOS users more reluctant to stray outside the Apple ecosystem for future purchases." Other services like the iCloud, Apple Pay and Apple CarPlay add another layer of stickiness to its products, broadening its loyal customer base.

Given the successful iPhone 6S and 6S Plus launch in September 2015--a record 13 million units were snapped up during launch weekend--Colello projects 28% revenue growth for Apple in 2015, including 52% revenue growth from the iPhone.

Digital storage company  Western Digital (WDC) primarily manufactures and sells hard drives, which make up 95% of revenue. Western Digital is evolving from a pure manufacturer of hard-disk drives to a broader storage company offering products and solutions including solid-state hybrid drives (SSHD) and solid-state drives (SSDs). The company has a vast global footprint with about 55% of its sales coming from Asia, 25% from the Americas and the rest from Europe, the Middle East and Africa.

Western Digital's sales have seen a 17% compound annual growth rate over the past decade, driven partially by acquisitions, says a Morningstar report. The company, adds the report, has about US$4.9 billion in cash and equivalents, roughly three times the cash required to run the business.

Morningstar equity analyst Peter Wahlstrom puts the fair value estimate for the stock at US$101, and expects the company to continue to expand in the enterprise SSD market, organically and through acquisitions. "We forecast that its SSD sales will grow 15% every year until 2020," says Wahlstrom, while projecting 2020 gross margin and operating margin assumptions of 28.8% and 12.5%, respectively.

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