Margin expansion has been a huge source of earnings growth as companies emerged from the recession lean and mean.
Revenue growth in the S&P 500 rose a solid 9.7% in 2010 (excluding financials). However, the real driver of income growth came from expanding profit margins.
Lean & Mean
Net profit margins increased from 7.1% in 2009 to 8.2% in 2010 as companies that slashed costs during the recession squeezed the most they could out of their resources.
This led to a whopping 27.4% increase in net income for the S&P - and a soaring stock market.
Net profit margins, calculated as net income divided by revenues, are expected to continue expanding, leading to more double-digit earnings growth in 2011. The net profit margin is expected to increase to 8.8% for the S&P 500. Combine that with projected revenue growth of 6.6%, and you get net income growth of 14.4%.
Not too shabby.
The Most Profitable Sector
So what sector is expected to see the widest net profit margins in 2011?
Computer and Technology.
The computer and technology sector is expected to see an incredible 16.3% net profit margin in 2011, up from 15.3% in 2010. That means for every $1 in revenue, companies keep an average of 16.3 cents after-tax. That's nearly twice the average of the S&P 500.
Moreover, revenues are expected to grow 10.7% in the sector, leading to net income growth of 18.3% in 2011.
Valuation is very reasonable too, with the sector sporting an average P/E of 15.0x 2011 earnings. That's a slight premium to the S&P multiple of 13.9x, but still well below its historical average.
Here are 4 computer and technology stocks looking attractive right now:
Check Point Software Technologies Ltd. (Nasdaq: CHKP) provides IT security solutions around the globe. It is best known for its firewall and virtual private network (VPN) products.
The company is wildly profitable, posting a remarkable 41.2% net profit margin in 2010. Earnings are expected to grow a solid 12% in 2011 based on the Zacks Consensus Estimate.
Check Point also has a pristine balance sheet with over $1 billion in cash and no debt. Shares trade at 19.8x forward earnings, a discount to the industry average of 25.9x.
It is a Zacks #2 Rank (Buy) stock.
Oracle Corp (Nasdaq: ORCL) continues to outperform expectations. The tech giant recently posted its fourth consecutive positive earnings surprise on 35% growth in revenues.
Estimates have been rising off the strong quarter, sending the stock to a Zacks #2 Rank (Buy). The company is expected to grow EPS a whopping 32% in 2011. Despite this, shares are trading at just 15.9x forward earnings.
Oracle has a 22.4% net profit margin over the last 12 months. It has also generated an average of $8.6 billion in free cash flow per quartersince the beginning of 2010. It currently pays a dividend that yields 0.6%.
Waters Corporation (NYSE: WAT) operates as an analytical instrument manufacturer for pharmaceutical, biochemical, and industrial companies. It designs and manufactures high performance liquid chromatography, ultra performance liquid chromatography, and mass spectrometry instrument systems and support products.
The company's net profit margin was an impressive 23.2% in 2010. Furthermore, EPS is expected to grow 14% in 2011 based on the Zacks Consensus Estimate.
Valuation is reasonable with shares trading at 18.9x forward earnings and a PEG ratio of 1.3.
WAT is a Zacks #2 Rank (Buy) stock.
Netease.com Inc. (Nasdaq: NTES) is one of the leading Internet and online gaming companies in China.
Estimates have been surging since NTES posted a 19% positive earnings surprise on February 23. The company also reported a fat net profit margin of 40.4% for 2010.
Analysts are calling for 23.9% EPS growth in 2011 based on the Zacks Consensus Estimate. It is a Zacks #1 Rank (Strong Buy) stock.
Valuation is reasonable with shares sporting a PEG ratio of 1.0. The stock is trading at 16.4x forward earnings, a discount to the industry average of 25.9x.
NTES is also financially sound with nearly $9.5 billion in cash and short term investments and no long-term debt.
As the U.S. emerged out of recession, companies were able to turn decent sales growth into huge earnings growth through expanding profit margins. These gains are expected to continue in 2011, particularly in the wide-margin computer and technology sector. With strong earnings growth expected and reasonable valuations, tech stocks are looking like an attractive investment.
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