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"There's a 'sector rotation' going on in the U.S. tech market right now. But it's not the kind that you normally see."
Radical Technology Profits Editor Michael Robinson, our resident tech-sector guru, shared that observation with me late Thursday night.
Or maybe it was early Friday morning.
You see, Michael and I were involved in one of our several-times-a-week conference calls. These calls almost always stretch on longer than we intended – just because they end up being so doggone interesting.
And the call late Thursday night (or early Friday morning) was no exception – which is why our long-distance chat was well into its second hour when I asked Michael to explain the once-white-hot tech sector's transformation into a "stock-picker's market."
We made that same observation to you folks in a recent Private Briefing report. And I was asking Michael to link that sector assessment with a new tech recommendation that we're sharing with you here today.
I've seen hundreds of these "sector rotations" play out during my 30 years in financial news. And I'm sure most of you folks have, too. But I wanted Michael to relate this rotation to what's happening in tech, because it's got some interesting features.
"When you're talking about a true 'sector rotation' – you know, in a classic sense – you're typically looking at Wall Street money pouring out of a recently white-hot sector and into another that's been lagging," Michael explained. "So after a period in which tech or biotech has been really, really hot, we might see money come out of those stocks and go into utilities, or transports, or energy. This time, however – at least in tech – what we're seeing is a rotation from one kind of tech stock to another."
In other words, investors haven't stopped buying tech stocks. They're just buying different tech stocks.
In essence, what's happening is that the big-money investment pros are shifting out of the high-flying "momentum" stocks that have led the Nasdaq Composite Indexhigher over the last two years. And they're shifting into more value-oriented tech issues – especially the companies that offer solid growth augmented with a nice dividend.
Let's consider a couple of examples, before we move on to today's recommendation.
They are stocks that you know very well …
From Leaders to Laggards to Leaders Again
With its Windows operating system installed on virtually all of the world's PCs – the market share peaked at about 95% – Microsoft Corp. (NasdaqGS: MSFT) became synonymous with the personal computer revolution.
And it didn't stop there. After locking up the operating-system market, Microsoft did nearly the same thing in the productivity applications market with its Office suite.
The breathtaking margins – 85% for Windows and 79% for Office — combined with the explosive growth of the PC market sent Microsoft shares on a 9,000% ride during the 1990s.
In recent years, though, it's pretty much been a sector laggard. For the two years ended Dec. 31, it gained roughly 27%. The Nasdaq gained 48% during the same stretch, meaning the index did 75% better.
Thanks, in part, to its 2.8% dividend, "Mr. Softy" has powered its way to a 10% gain so far this year. The Nasdaq has dropped 1.6%, meaning the software heavyweight has generated a relative outperformance of nearly 12%. (Interestingly, thanks to an early July recommendation by Capital Wave Forecast Editor Shah Gilani, we've captured a good chunk of this run for all of you).
Even if Microsoft does nothing for the rest of this year, you can tack on the 2.8% dividend yield and end up with a "total return" of nearly 13%.
Then there's Cisco Systems Inc. (Nasdaq: CSCO). Cisco – the maker of the switches and routers that form the backbone of the Internet – saw its shares zoom 66,000% during the 1990s, thanks to booming PC sales, the exploding popularity of the Internet, and the widespread realization of the value of networking.
That mesmerizing surge gave the San Jose-based company a peak market value of $555.4 billion, an amount that wouldn't be matched again for a decade – and not by Cisco.
Over the last two years, Cisco stock has gained nearly 14%, meaning it, like Microsoft, lagged the Nasdaq's 48% burst.
So far this year, however, the networking giant is up about 5%, not counting its 3.3% dividend, meaning that it is beating the bellwether tech index by a relative 7%.
"There's a message here, Bill: With tech stocks, growth and dividends aren't mutually exclusive – especially right now," Michael said. "Indeed, dividends are right now being valued almost equally with growth, meaning a stock's 'yield' is actually one of the catalysts that can attract buyers and drive it higher in price."
Some recent research adds strength to Michael's conclusion.
From late 2007 to the midpoint of last year, tech accounted for more than 54% of the increase in dividends, according to a report released by WisdomTree and Bloomberg.
And in last year's third quarter – the most recent data available – the information-technology sector led the market with annual dividend growth of 46%.
And that brings us to today's recommendation: The Little Rock, Ark.-based Windstream Holdings Inc. (NasdaqGS: WIN), a telecom-tech company that offers modest growth – and a mammoth dividend.
"Bill, we're talking about a $9 stock that pays an 11% dividend – and that I believe could surge as much as 75% over the next three years," Michael said. "Taken together, you're talking about a big, big total return on a very-low-priced stock."
So let's take a closer look …
In most cases, a low-priced stock is a junkyard refugee.
But that's not true of Windstream, which is why the stock is so intriguing.
It's both a Fortune 500 company and a member of the Standard & Poor's 500 Index. And Windstream says it is the "provider of choice" for four out of five Fortune 500 companies for data, voice, network, and cloud-based solutions – that is, applications and other content delivered from remote data centers.
Windstream is what we like to refer to as a "special situation" play. That's because it is a company in transition: Its management team has engineered a major transformation over the last several years. And there's still work to be done.
Windstream, you see, wasn't always successful.
Back in 2006, the company was largely focused on providing rural residential Web, phone, and related services. The company was anything but a technical leader: Its rivals had much stronger networks, and it was badly behind the times.
With the rise of online music, gaming, and movies, millions of consumers clamored for fast Web connections. Yet, broadband services only accounted for 38% of the company's revenue.
And though its roots reached all the way back to the World War II days of 1943, eight years ago Windstream had customers in only 16 states. A map of its operations showed little in the way of any strategic thinking. It had operations and customers in Texas and in central New York State, with no links between the two.
That all changed in July 2006, which is when the sleepwalking telecom was spun off from Alltel Holding Corp. CEO Jeff Gardner wasted little time plotting an aggressive growth strategy that generated enormous free cash flow.
Today, Windstream operates in 48 states and 86 top metropolitan markets. It has 115,000 miles of high-speed fiber-optic cable for Web and voice services. And broadband now accounts for nearly 75% of its sales.
In fact, Windstream now has some real muscle. It runs 26 data centers throughout the United States and counts more than 3.3 million consumers and 600,000 businesses as clients.
This is now a firm that offers a deep list of products and services. And that includes such technically sophisticated offerings as network routers, Web hosting, database management, and Internet security.
That build-out of its network and Windstream's growing list of services has paid off in new sales. Since the spinoff, the company has roughly doubled in size, to about $6 billion last year.
But the big story here is cash flow.
And Michael can explain why.
Cash Flow – Not Profits – is the Ultimate Goal
Senior executives talk about cash flow – actually free cash flow (FCF) – as the metric used to measure the company's financial strength, and to assess how it's treating its shareholders.
In some ways, it's a better measure than net income, the bottom-line accounting term we use to compare one company to another. Cash flow, you see, adds back in such "paper" – or non-cash – subtractions as depreciation and amortization.
Last year, Windstream generated nearly $891 million in free cash flow- equal to nearly 15% of sales. Of that total, the company paid out $595 million in cash dividends.
In other words, the company paid dividends that amounted to 67% of its adjusted free cash flow.
Here's just how important that dividend commitment really is. Windstream reported 2013 income of about $241 million. In other words, for every dollar in earnings, it paid dividends of about $2.46.
Bear in mind, this company is no slouch when it comes to the overall financials. It has operating margins of 17.5% and a 24% return on stockholders' equity (ROE).
Sales were flat in 2013, but profits roared ahead in the fourth quarter. After a series of accounting adjustments, WIN reported earnings per share (EPS) of 9 cents, a year-over-year jump of 350%.
Trading at about $9 a share, Windstream has a market cap of $5.3 billion and an 11% dividend.
With Windstream, you get one of the market's higher dividend payers – at a time when Wall Street is shifting massive amounts of cash to high-yielding stocks.
"The bottom line here, Bill, is that this stock is priced for a big move higher," Michael said. "In my opinion – and I believe my analysis backs this up – Windstream is currently twice the company it was back in early 2007, when the stock traded as high as $15.44 a share. And if the stock could just get back to its 2007 high, you're looking at a gain of roughly 75% from current levels."
In short, this looks to be a very special "special situation."
And in a "stock-picker's market," that's just the kind of opportunity to look for.
A Look Ahead
Despite this shift from tech growth to tech value, Michael hasn't soured on some of the former highflying leaders. He's expecting more-consistent economic reports will start to show up in the next few months. And that will induce the investment pros to shift money back to the growth leaders that are building the "new tech" economy.
"Bill, things like sensors, Cloud Computing, Big Data, Internet of Everything, Miracle Materials, Mobile communications, aerospace, cybersecurity and biotechnology – all of which your readers have capitalized on in a big way the past two years – offer too much upside to just 'go away'," Michael said. "These are not merely powerful trends on their own – these are convergent trends that, as you've written, are creating entire new 'ecosystems." And in tech, an ecosystem is a synonym for 'big profit opportunity.' In fact, what I believe will happen is that these stocks will soon become so incredibly cheap that we'll start buying into them to get our positions locked down in advance of the big return by Wall Street. So we'll make a killing in tech value right now with stocks like Windstream … and we'll beat Wall Street to the draw in the shift back to tech growth … making a killing there, too."
That sounds like a recipe for big-time profits.
And I'll bet it sounds as good to you as it does to me.
We'll stay on this one.
In the meantime, have a super week.
[Editor's Note: Unless otherwise directed, we recommend investors employ a 25% "trailing stop" on all holdings.]
- Private Briefing: Shah Shares His Latest Views on Microsoft, Apple and Facebook.
- Money Morning: After a Decade of Miscues, Can Microsoft Corp. (Nasdaq: MSFT) Hook Up With the Mobile Revolution?
- Money Morning: Once the Planet's Most Valuable Company, Cisco Systems Inc. (Nasdaq: CSCO) Now Seeks to Rebound From a Decade of Stagnation.
- Private Briefing: Guess Who's Going to Be the "Google" of the "Internet of Everything."
- Private Briefing: Our Experts Show You the Stocks to Pick in a "Stock-Picker's Market."