There are more than 1100 tech stocks domestic to the U.S. markets, even among the 500 largest companies in the United States, 75 of them are in the tech sector.
But only seven are the best of the best, just seven-tenths of a percent, less than one-in-100 tech stocks made the list into the new Bow Tie Index!
I am excited about this new index, ticker BOWT, an official index to follow the best stocks in the market.
I’ll show you how the index works, it’s potential to beat the market, then I’m going to highlight those seven tech stocks I’m buying. These are stocks of companies leading their industries with competitive advantages they can turn into profits and returns for investors.
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If you want to see all the stocks in the index, go to Stockcard and to the Idea Center, click on Indexes and you’ll find the Bow Tie Index. From there you’ll see the methodology we’re using to pick stocks, the videos detailing it, some great ways to contribute your own ideas and the stocks in the index and their percentage.
Don’t forget to follow the index to get early access to videos and be the first to see when I add a stock to the group.
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I showed you how the index is set up in last week’s video, The Bow Tie Index is the top 10% of the large cap stock market, the best one-in-ten stocks among the 500 largest companies based in the United States. You can see in back-tested results over the last five years, investing in these best of breed stocks would have outperformed the SPY fund by more than 50% so there is definitely something here.
I’m going to link to last week’s video in the description so check that out for the complete process of how I’m picking stocks in the index. We’ve got a big video today so I want to get straight into those eight tech stocks to buy.
First on our list of tech stocks is Applied Materials, ticker AMAT, one of the first in semiconductors since 1967.
AMAT is the leader in semiconductor equipment and tools, the picks-and-shovels play for the growing semiconductor industry. Basically, there’s a gold rush in semiconductors because these are the brain of any electronic device. The Internet of Things and AI revolution is driving huge demand that has taken stocks like Nvidia skyward and Applied Materials provides the key components that go into semi production. Besides the core semiconductor systems and services, the company also has a display segment for OLED and flat-panel displays. Revenue has been trending lower on the semi segment but has held fairly consistent in the other two over the last year.
If you didn’t catch our first video in the series, make sure you check out that link in the description below. I outlined the quantitative factors like sales growth and operating margin we’re using to pick the best stocks for the Bow Tie Index.
And Applied Materials meets all these factors with three-year sales growth over 25%, well over the industry average, as well as an operating margin that is nearly six-percent higher than peers in the industry.
Why we’re looking for faster sales growth and operating margins is to clue us in on competitive advantages in companies against the peers in their industry. It’s a way to measure those factors that aren’t as easily measurable. Applied Materials is growing sales faster than the competition, taking market share from them, and it’s able to do it at a more profitable rate.
Like a lot of the tech stocks we’ll see in the list, AMAT’s advantage comes from innovation and it’s ability to continue to innovate. The company’s $2.7 billion budget for research and development is tough to beat by smaller competitors and has helped it be first in industry changes like the recent changes to 3D architecture and field-effect transistors. It’s really allowed it to build a portfolio of products that can’t be matched.
Now about 30% of the company’s revenue is into China so the escalation of the chip wars is concerning but AMAT has applied for special export licenses. A big part of the business to China is in the flat-panel display business rather than semiconductor equipment so that will moderate any loss.
On a valuation basis, we find a stock that isn’t overpriced like a lot of the companies in its industry. The average price-to-sales ratio in semiconductors is 4.9-times, firmly in growth stock territory for valuation and a little expensive given the economic situation we’re watching. But shares of AMAT trade for just 3.1-times sales, more than a third cheaper than the industry despite being clearly one of the best stocks in the group.
Analysts see a lot of upside here with a target price of $133 per share or about 50% higher over the next year.
One stock I’ve been watching closely for a recent acquisition, Broadcom Inc, ticker AVGO.
Through acquisitions, Broadcom has patched together one of the broadest leaderships in tech from smartphone components to wired infrastructure and storage to semiconductors. If you want one tech stock that is going to benefit from the strongest trends like robotics, Internet of Things and 5G, this is it.
Broadcom has lagged the industry a little in sales growth with a 10% annual growth rate versus a 12% average in the industry. That weakness disappears though when you consider the company’s operating margin of 31%, nearly 8% higher than the industry’s average profitability.
Because of its size, Broadcom may not grow as fast as the industry but it’s one of the most efficient and can convert much more of its sales into profits.
The increase in network demand with 5G technology could mean a spike in demand for Broadcom’s RF filters but it’s the acquisition of VMware that has me most excited. The $61 billion deal is expected to close next year and will add VMware’s dominance of the enterprise cloud market to Broadcom’s leadership in infrastructure software. It fills the few gaps in Broadcom’s business and gives it a strong defensible advantage on the enterprise side of IT.
And for all the worries about Broadcom’s acquisition history, basically going in and driving massive restructurings at the target company…it’s hard to argue the success it’s had for investors. Broadcom management believes it can nearly double VMware earnings to $8.5 billion within three years of the closing.
Analysts think that VMware acquisition can help take shares of Broadcom up to a target of $675 over the next year, more than 45% from where it trades now.
We’re just getting started but I’ve been promising for weeks to show you the qualitative factors I’m using to pick stocks for the index. I showed you the quant factors in our first video but these are just as important…maybe even more important.
Those quantitative factors like finding companies with the best sales growth or profitability, those are numerical ways of doing exactly what we’re trying to do with these qualitative factors. We’re saying that a company with stronger sales growth versus competitors or better profitability could have some kind of competitive advantage or better management that’s enabling that growth. They are taking market share from competitors for a reason.
This is what makes strong, long-term returns in a stock. It’s why Amazon is a trillion-dollar company and nobody remembers SquirrelCart anymore. It’s why we talk about Shopify instead of LemonStand.
The qualitative factors like product innovation, market positioning and strength of management then are just more direct ways of looking at this. We’re trying to find the advantages a company has that enables that stronger sales growth or the profitability.
So I want to walk you through these briefly, give you a sense of how to find these when you’re looking at stocks.
Product innovation and market positioning is how unique a company’s product is and whether it’s different enough to really stand out. That’s going to mean a lot for the prices a company can get, whether it can charge more or if it has to compete on the lowest price possible. Market positioning is important because company’s with a dominant position, controlling more of the market can get economies of scale that drive profits.
Strength of governance and management looks first at how well the board of directors focuses on shareholder interests or are they just there to line their own pockets. We also want to find management that is able to perform in any market and economy.
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Finally here, competitive advantages brings this all together to look for the companies with a defensible advantage that allows them to take market share or better pricing power.
Semiconductors is where the growth is and our next stock, Skyworks Solutions, ticker SWKS, has a history of innovation.
The company provides frequency components, so switches, filters and amplifiers for the wireless handset market along with other wireless connectivity. Because 5G uses a wider spectrum and band frequency, growth in demand for these components is booming and should continue to grow for years.
And where the company used to be all about smartphone handsets, now 40% of sales are in broader markets like Internet of Things, Automotive and Industrial.
Skyworks grew its revenue by 23% annually over the last three years, well above the 20% annual growth in the industry and that outperformance has increased recently with a 52% year-over-year sales growth in the most recent quarter.
The company is able to command a higher price for its products and is more efficient in its expenses, meaning it’s also able to turn that sales growth into earnings.
There’s a reason why Skyworks is able to get a higher price for its filters. The SkyOne suite of products is really innovative in its ability to integrate several radio frequency needs into a single product and the tech has proven difficult to copy.
That expertise and innovation is just starting to translate outside of smartphones for Skyworks but it could mean even stronger sales to come as the company diversifies.
Skyworks has one of the highest potential upsides according to analysts with an average target of $141 per share, nearly 65% higher from here.
This next tech stock, Adobe, ticker ADBE, just made an acquisition that could significantly improve its reach.
Adobe is more than just the pdf file provider but a content creation, document management and digital marketing leader. It’s Photoshop and Illustrator products are the go-to in editing and it’s moved products into the cloud for a subscription revenue model, something that should help it smooth growth and build momentum.
Adobe’s three-year growth rate in sales of almost 19% is more than one and a half times that of the industry and sales growth increased further to 22% in the most recent quarter.
Remember, that’s one of the important factors we’re watching, not only that sales growth is beating peers but it’s also increasing over time.
Adobe is doing with its Photoshop and other content creation products what it did with Acrobat which is now the default PDF file format and a $2 billion business for the company. There’s really no alternative for a lot of these software suites and Adobe does a great job of cross-selling once it has you hooked into one of its products. And where some have questioned the price tag for the recent Figma acquisition, it really does help bring Adobe into team collaborations versus primarily a single user kind of product.
The drawback to shares of Adobe is they do trade on the expensive side versus peers. A price-to-sales ratio of 8.8-times is very high even for a growth stock and well above the valuation you pay for other stocks in its industry.
That’s why there’s not quite as much upside here with an average analyst target of $412 per share but that’s still 28% higher for a one-year target and the company will continue to grow from there.
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Arista Networks, ticker ANET, recently saw shares jump 9% on news that could mean even stronger revenue growth.
Facebook parent, Meta Platforms, is one of Arista’s biggest customers for the high-speed switches the company sells to data centers. Besides just generally strong growth for data centers and Arista’s competitive advantage that I’ll talk about, Meta’s capital spending plans for the next year could mean a bigger revenue boost for Arista. It was bad news for Facebook investors on the higher spending but great for Arista.
Arista has lagged peers in revenue growth over the three-year period with 10% annual growth versus 14% for the industry but we’ve seen this turn around lately with 20% year-over-year growth in the last quarter versus just 2% for the industry.
So it does appear that even as the economy is weighing on Arista’s industry, the company is doing really well and growing even faster.
Like we saw before, I’m willing to give the company a pass on that slower long-term revenue growth when looking at profitability because Arista’s operating margin is almost twice the average for it’s industry with an operating margin of 31% versus just 16% on the average.
Arista took leadership from Cisco in the market for data center switches almost a decade ago and it’s built on it since. The company now controls about a third of the market for high speed switches because they perform so well at the speeds enterprise clients need.
Another advantage is in Arista’s decentralized product with open structure. That’s different from Cisco which tries to lock customers into its ecosystem of hardware and software. Customers like the flexibility Arista gives them with building out the data center and it’s helped grow that market share advantage.
Arista has the weakest potential upside to the average analyst target, mostly because it hasn’t fallen like so many other stocks. Shares are down just 7% this year and have 11% upside to the average target of $131 per share.
I really wanted to get a cybersecurity company on the list for growth and am buying Fortinet Inc, ticker FTNT.
Between ransomware, state-sponsored attacks and just general cybercrime, no industry has the growth as cybersecurity. Fortinet leads in its space with a hardware and software package along with cloud services to grow into what’s expected to be a $200 billion market by 2026.
Fortinet blows the competition out of the water in growth with a 24% annualized sales growth over the last three years, four-times the industry average. Not only is it growing faster but more profitably as well with an operating margin of 19% versus 14% for the industry.
The company dominates the market for firewall shipments with a 37% share and nearly three-times the size of its next largest competitor, Cisco with just 13% of shipments. And it’s built this from a leadership in the convergence of networking and security, providing a single solution for security-driven networking through its operating system.
That’s a defensible competitive advantage that the company will use to continue growing its market share and revenue and I think Fortinet is one of my favorites for this group.
Analysts have an average target price of $71 per share over the next year, about 27% from the current price.
I’ll reveal that last tech stock next, one that I’ve held in my own portfolio for years and is one of my biggest investments, but anytime you’re focusing on a single sector like this, you want to make sure you have good exposure across the industries.
Remember, a sector is a larger segment of the economy so you’ve got sectors like technology, energy and healthcare. Within each sector, you have industries of companies that create products to serve a very similar need. Within Consumer Staples, you have industries like beverages, food and retailing, household and personal products. Within the tech sector, you’ve got communications equipment, electronics, IT services, semiconductors, software and hardware.
In our list of best eight tech stocks, we have three companies in the semiconductor and semi equipment industries, three companies making software infrastructure and one in software application and then one company that makes computer hardware.
Why this is important is for the same reason you want to add stocks from different sectors to your portfolio. Focusing on just one industry means all the volatility and risk of that one industry. Making sure you have stocks in different industries and across the sectors smooths out your risk so your portfolio doesn’t crash with any one group.
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All you out there in the Bow Tie Nation probably won’t be surprised by this one, one of my favorite long-term stocks Salesforce, ticker CRM.
The company is leading in some of the biggest themes that will change our world over the next decade including: AI, Remote Work, Cloud and Data across an addressable market CRM estimates at $248 billion.
Salesforce controls nearly 20% of the global market customer relationship management software and services. That’s four-times the next closest competitor, Oracle, with just 4.8% share.
The company is able to translate that size into a competitive advantage to drive 24% sales growth, well over the 15% average for the industry, on its ability to cross-sell products.
One of the larger companies in the group, you wouldn’t expect the upside to be as strong but analysts have a $216 price target on the shares, 34% higher from here.
