2 tech stocks to buy for capital gains

The MoneyLetter recently took a look at two of the five so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, and Alphabet’s Google) that have led the market higher in recent years. Apple and Netflix are both ‘buys’ for long-term share price gains and Apple is well on its way to becoming a dividend aristocrat.

Tech_Stocks_for_Capital_GainsApple Inc. (NASDAQ—AAPL) is one of the largest manufacturers of personal computers (such as the Macintosh), peripheral and consumer products. These include the iPod digital music player, the iPad tablet, the iPhone smartphone and the Apple Watch.

The company sells mostly to the business, creative, education, government and consumer markets. Apple also sells operating systems like iCloud storage and Apple Pay as well as a lot of digital content from the iTunes store and other portals.

In the year to Sept. 30, Apple is expected to earn US$11.76 a share. That would mark a 28 per cent jump from last year’s US$9.21 a share.

The forward-looking stock market, however, is focusing on the outlook for fiscal 2019. Apple’s earnings are expected to climb by 13.9 per cent, to US$13.40 a share. Based on this estimate, the shares trade at a P/E (Price-to-Earnings) ratio of 16.7 times. That’s reasonable for this highly profitable and diversified company. That’s likely why billionaire Warren Buffet bought it.

Apple began paying dividends in 2012 at US$0.38 a share. The company has raised its dividend each year since then, to US$2.92 a share today. Despite a 7.7-fold rise in the dividend, it yields a small 0.17 per cent. That’s because the shares have risen so much. In fact, that’s how Apple became the first US company to reach a market capitalization of US$1 trillion.

We expect Apple to continue to raise its dividend each year and eventually become a ‘dividend aristocrat’. In the US, this refers to companies that have raised their dividends for at least 25 consecutive years.

We also expect Apple to continue to repurchase its shares. After all, it generates more cash flow than it needs to fund its research and development and its capital investment.

It rewards its shareholders in two ways. Most important, the company raises its dividend every year. It also buys back its own shares. In fiscal 2012, Apple’s share count peaked at 6.575 billion. Since then, it has repurchased its shares every year. The share count is now down by over a quarter, to 4.915 billion.

Spreading the earnings over fewer shares raises Apple’s earnings per share, of course. All else being equal, this justifies a higher share price. Meanwhile, growing dividends attract income-seeking investors who can bid up Apple’s share price. It remains a buy for further long-term share price gains and modest, but growing dividends.

Buy Netflix for share price gains

Netflix Inc. (NASDAQ—NFLX) is the world’s largest Internet television network. At last count, it served 130.1 million streaming members in over 190 countries. Since June 30, the company also rents DVDs to its members in the US.

Netflix is growing quickly. In 2018, it’s expected to earn $2.67 a share. That’s more than double the $1.25 a share that it earned last year. Based on this year’s estimate, the stock trades at a high P/E (Price-to-Earnings) ratio of 133.2 times. The thing is, the forward-looking market’s focus is shifting to expectations about next year. In 2019, Netflix’s earnings are expected to jump by 60 per cent, to $4.27 a share. Based on this estimate, the stock trades at a better, but still-high, P/E ratio of 83.3 times.

Fast earnings growth can justify a higher P/E ratio. The trouble is, stocks can become what’s known as ‘priced for perfection’. That is, the market’s expectations become so high that it’s difficult for a stock to meet these expectations. If it does very well, but less well than the market expected, the share price can plunge. The stock market is, of course, erratic and unpredictable. It puts ‘fallen angels’ in the ‘doghouse’ for a while.

One positive aspect about Netflix is that it generates recurring and dependable cash flow. Subscribers around the world pay modest monthly fees for access to its offering of popular TV series and movies. This gives the company the money to continue to expand its business.

Competitors are springing up to try to eat some of Netflix’s lunch. These include Amazon.com, HBO and Hulu, among others. Analyst Robert Harrington wrote, “. . . new products are liable to threaten [Netflix] as well. Specifically, Disney’s impending launch of an ‘over-the-top’ product could pose a notable challenge. The House of Mouse is pulling its films and television shows from Netflix in anticipation of its proprietary product’s introduction.”

On the positive side, Netflix is producing more content of its own. For instance, it recently increased its 2018 programming spending from $8 billion to $13 billion. Netflix has won many Emmy nominations. This in-house production exclusively for its members can help Netflix compete against its rivals.

Netflix is a buy for long-term share price gains, if you need no dividends.

This is an edited version of an article that was originally published for subscribers in the October 2018/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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