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Tech Most Popular Sector for Investment Fund Managers in 2017

- By Holly LaFon

Data show that Silicon Valley darlings once again captured the interest of stock fund managers looking to cash in on the sector's growth and dreams in the fourth quarter of 2016.

In a ranking of the 20 S&P 500 stocks that U.S. funds managing more than $1 million bought the most, tech companies took eight spots: Microsoft (MSFT), Apple (AAPL), Alphabet (GOOGL), Facebook (FB), Amazon (AMZN), Cisco (CSCO), Alphabet (GOOG) and Intel (INTC). Microsoft and Apple also saw the most buying in the S&P 500, according to data compiled by GuruFocus.

The results show U.S. investment fund managers packing into a market sector that already sprinted through last year, gaining 23.5% in 2016 versus 9.54% in the S&P 500. So far, it has not broken a sweat going into 2017, rising 29.49% year to date versus 5.58% in the S&P 500. Only one sector has outperformed it, financials, which rose 44.90% year to date on the back of investor optimism in future tax cuts and interest rate hikes.

Some research indicates investors can expect further growth for tech. Global information company The NPD Group forecasts 2% growth in technology industry sales in 2017 from 2016, driven by innovation, new products and low prices. A gaggle of fresh product categories is also slated to lure more buyers, like drones, virtual reality and home automation products, in addition to seasoned products like TVs and PCs in the premium space.

For just one product, drones, NPD researchers anticipate 177% in sales growth from 2016 to 2018, led mainly by hobbyists. Less tech-savvy consumers may also begin to get on board with smart home devices, where NPD predicts 80% growth over the same period.

Other megatrends continue down the pipeline, like cloud computing, big dada and artificial intelligence, but some market watchers see reason for worry.

"Looking at the other side of these favorable long-term trends, I remain wary of certain hardware companies whose products are becoming commoditized. For example, in the personal computer market, virtual reality headsets and computers are an opportunity for growth, but so far, demand has been largely anemic," said one analyst, Charlie Chai of Fidelity in a sector outlook."

"The smart-device market is increasingly saturated and lacks products capable of driving sustainable new excitement. On the enterprise hardware front, there continue to be many technology disruptions, which increase the long-term risks for some incumbents. Although valuations are generally low for enterprise hardware companies, I continue to struggle with their challenging long-term outlooks."

Employment momentum has carried over into 2017, indicating companies see these opportunities expanding. The tech industry added a net 9,000 jobs in the IT sector in January, according to the Bureau of Labor Statistics. The highest employment growth occurred in software and technology services where 12,500 jobs were added, extending growth of 73,900 jobs in 2016, despite layoffs at numerous companies.

Earnings growth has supported tech's rally. Of the 408 companies that had reported earnings as of Feb. 17, tech led all sectors with a 12.1% increase year over year, amounting to an additional $68.2 billion. Eight of the 11 sectors were expected to finish the quarter with improved earnings, according to Thomson Reuters. Yet when removing sub-industries with the highest growth, semiconductor equipment and electronic manufacturing services, the growth rate declines to 11.1%, more in line with financials and utilities.

The S&P North American tech sector index had a trailing price-earnings ratio of 28.07 and projected price-earnings ratio of 20.47 as of Jan. 31. It also had a price-book ratio of 4.92%, price-free cash flow ratio of 16.52 and dividend yield of 1.21%. Its largest constituents are Apple, Microsoft, Facebook and Alphabet.

Microsoft, favorite of most U.S. funds, grew fourth-quarter revenue 1.23%, operating earnings 2.5% and earnings 3.62% from the prior-year quarter, on the strength of cloud and office products and services. Personal computing fell 5% primarily by a drop in gaming revenue and its feature phone business, which it sold in November. During the quarter, the company returned $6.5 billion to shareholders in share repurchases and dividends.

Donald Yacktman (Trades, Portfolio)'s Yacktman Fund (Trades, Portfolio)s commented on the company in its recent letter, "Microsoft's shares were solid contributors to fourth-quarter results as the company continues its remarkable transformation under CEO Satya Nadella. Microsoft could be a significant beneficiary of the new administration's proposed tax repatriation plan."

The biggest guru investor in Microsoft is Jeff Ubben (Trades, Portfolio), who has 19.71% of his reported portfolio in the company.

Apple's performance also shined in most categories, with all-time sales record for its iPhone, services, Mac and Apple Watch. Fourth-quarter revenue rose 3.19%, and EPS increased 2.44% to an all-time high. Earnings for the company struggled, though, falling 2.62% year over year, as net and gross margins declined. Apple returned $15 billion to investors in share repurchases and dividends during the quarter. CEO Tim Cook also hinted at "products in our pipeline."

A guru Apple shareholder, David Rolfe (Trades, Portfolio), commented in his Wedgewood Partners recent letter, "Clearly the Company does not need to spend $10-$15 billion per year to sustain the evolutionary upgrades to the iPhone, iPad, Apple Watch and/or new video streaming services. Apple's nascent automotive program Project Titan may not be at all about creating a complete autonomous driving car (Apple Car), but rather the creation of software that makes existing cars smarter - or even autonomous. Now that is a huge, creatively disruptive opportunity."

Apple's top guru shareholder is David Einhorn (Trades, Portfolio), whose Greenlight Capital has 11.56% of its assets in his reported long portfolio in the stock. Another famous shareholder, Warren Buffett (Trades, Portfolio), owns 1.09% of Apple's shares, which make up 4.49% of Berkshire's portfolio. He added more than 42 million shares of the company in the fourth quarter.

See more of fund manager's favorite S&P 500 stocks of the recent quarter here.

This article first appeared on GuruFocus.