The Zacks Computer - Networking industry includes providers of networking and Internet connected products such as wireless (WiFi and LTE), Ethernet and powerline, with a focus on reliability and ease-of-use.
The industry is likely to get a boost from increased focus on cloud computing and cloud storage. Further, this industry is characterized by brisk technological change, rapidly progressing products, high-speed connectivity, low latency, and evolving industry standards. Also, the demand for Computer - Networking industry is likely to be fueled by skyrocketing connectivity demands of mobile workforces, rise of the Internet of Things (IoT) and increase of cloud applications.
However, there are reservations regarding near-term growth prospects of Computer – Networking industry owing to the ongoing and heavily time-consuming business model transition to cloud. Furthermore, distributed denial-of-service (DDoS) attacks have become increasingly popular with cyber attackers, affecting the reliability of critical infrastructure and national security. These factors remain key concerns for this industry.
Further, the ongoing trade war between the United States and China has created an uncertain environment that is not conducive for investments. Moreover, foreign exchange volatility, sluggishness in global economic growth and shift in consumers buying patterns is likely to dampen growth prospects of the industry.
Industry Offers Solid Shareholder Returns
The Zacks Computer - Networking Industry, within the broader Zacks Computer And Technology Sector, has outperformed both the S&P 500 and its own sector over the past year.
While the stocks in this industry have collectively gained 42.5%, the Zacks S&P 500 Composite and Zacks Computer And Technology Sector have rallied 15.9% and 18.1%, respectively.
The performance of both the sector and the S&P 500 can be attributed todata demand explosion, advent of high-speed LTE networks and proliferation of smartphones.
Stretched Valuation a Concern
However, valuation of the Zacks Computer - Networking industry looks stretched at the moment. The industry primarily comprises growth companies that are investing heavily in research & development (R&D) to boost the top line.
So, one might get a good sense of the industry’s relative valuation by looking at its price-to-sales ratio (P/S), which reflects how much investors are paying for each dollar of revenues generated by the company.
The Computer - Networking industry currently has a trailing 12-month P/S ratio of 4.54, which is in line with the highest level in the past year.
The space also looks expensive when compared with the market at large as the trailing 12-month P/S ratio for the S&P 500 is 3.48 and the median level is 3.37.
Moreover, a comparison of the group’s P/S ratio with that of its broader sector confirms that the Zacks Computer - Networking industry is trading at a significant premium. The Zacks Computer and Technology Sector’s trailing 12-month P/S ratio of 3.76 and the median level of 3.68 for the same period are way below the Zacks Computer - Networking Industry’s respective ratios.
Improving Earnings Outlook to Drive Outperformance
Robust market adoption of cloud computing, big data, IoT, VR, and AI will continue to drive the industry and has encouraged many companies to raise their outlook for the current fiscal year. This optimism is likely to aid Computer – Networking stocks generate positive shareholder returns in the future.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the earlier valuation analysis reflects that there is little upside left, there are enough reasons for investors to continue looking for a good entry point.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $2.28 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company in the Zacks Computer - Networking industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the EPS of the industry for 2018, but how this projection has evolved recently.
As you can see here, the $2.28 EPS estimate for 2018 has remained steady from the end of August, and improved from $2.27 at the end of July. In other words, the sell-side analysts covering the companies in the Zacks Computer - Networking industry have been proactive in raising their estimates.
Zacks Industry Rank Indicates Bleak Near-Term Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term.
The Zacks Computer - Networkingindustry currently carries a Zacks Industry Rank #222, which places it at the bottom 13% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has continuously deteriorated for the last eight weeks.
Now, looking at the past revenue performances, the prospect of the industry also looks bleak.
Sluggishness in global economic growth, shift in consumers buying patterns and transition to cloud could weigh on the prospects of the Computer – Networking industry.
Despite stretched valuations, investors can build positions in the Computer Networking industry based on increased focus on cloud computing and cloud storage as well as strong earnings outlook.
Below are two stocks that carry a bearish Zacks Rank that we would recommend investors to stay away from for the time being.
NETGEAR, Inc. (NTGR): Provider of networking, storage and security solutions carries a Zacks Rank #5 (Strong Sell). The stock has gained 21% over the past year. The consensus EPS estimate for the company has declined 16.8% for the current year, over the last 60 days.
NetScout Systems, Inc. (NTCT): The business assurance provider carries a Zacks Rank #4 (Sell). The stock has lost 24.8% over the past year. The consensus EPS estimate for the company has decreased 2.2% for the current year, over the last 60 days.
However, there is one stock that investors can pick to gain a footing in this industry. This stock has been witnessing positive earnings estimate revisions. It carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Cisco Systems, Inc. (CSCO): An IP-based networking company has a Zacks Rank #2. The stock has returned 46.6% over the past year. The Zacks Consensus Estimate for the current-year EPS has increased 3.1% over the last 60 days.
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