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2017 was a very good year for the markets. The S&P 500 Index is on pace to deliver a 20% return. The technology sector was one of the market leaders this year; the Technology Select Sector SPDR ETF (NYSEArca: XLK), a basket of large-cap tech stocks, is up 33% year-to-date.
Despite the run-up among tech shares this year, there could be more room to run in 2018. Tech stocks are still growing earnings at a high rate, have excellent balance sheets, and many stocks remain modestly priced.
In addition, a few large-cap tech giants have tens of billions in cash on the books. With tax reform in place, this cash could be put to work to further enrich shareholders.
Here are three tech stocks for 2018 that could continue to lead stock market gains in the new year.
Tech Stocks for 2018: Apple (NASDAQ: AAPL)
Apple has had an impressive rally in 2017, up over 50% year-to-date. Apple grew revenue by 6%, and earnings increased 11% last fiscal year, due in large part to higher device sales and iPhone pricing.
Another catalyst for Apple is its booming services business, which includes iTunes, the App Store, Apple Pay and more. Services revenue is now a $30 billion-a-year business for Apple. Services revenue grew over 20% in the most recent year.
Apple has a P/E ratio of 19, while the S&P 500 Index is valued at a P/E above 25. Apple is the strongest brand in the world and earnings are growing at a double-digit rate, which means the valuation multiple could expand further.
For 2018, Apple will benefit greatly from new iPhone releases, including the iPhone 8 and iPhone X. Since the iPhone itself represents more than half of Apple’s total revenue, this is a major catalyst. Plus, Apple ended last quarter with $268 billion in cash and long-term investments on its balance sheet.
Tax reform is another catalyst that could incentivize Apple to bring some of that cash back to the U.S., and reward its shareholders with higher cash returns.
Tech Stocks for 2018: Microsoft (NASDAQ: MSFT)
Apple’s momentum is building, and Microsoft is not far behind. Microsoft’s renewed growth is the result of a long turnaround. Global PC sales have declined over the past several years. In response, Microsoft has turned to the cloud.
Microsoft’s adjusted revenue increased 5%, while earnings rose 19% in fiscal 2017. It has done equally well in the current fiscal year—revenue and earnings increased 12% and 17%, respectively, in the fiscal 2018 first quarter.
Microsoft’s growth is due largely to its cloud-based software platforms, Office 365 and Azure. Office 365 Commercial revenue soared 42% last quarter. Dynamics revenue increased 12%, driven by the shift to Dynamics 365. Total commercial cloud revenue increased 55% last quarter.
Microsoft ended last quarter with over $143 billion of cash, cash equivalents and investments on the balance sheet. Like Apple, Microsoft would be a huge winner of tax reform, such as a reduction in the repatriation tax rate.
Tech Stocks for 2018: Cisco Systems (NASDAQ: CSCO)
Cisco has certain legacy businesses that are slowing, including its core routers and switching segments. But these categories are saturated, and in decline. Routing and switching revenue each decreased by 9% last year. As a result, Cisco’s overall revenue declined 2.5% in the most recent fiscal year.
However, Cisco is positioning itself for the future, by investing in new growth areas such as wireless, security, and the Internet of Things, or IoT. Wireless and security revenue increased 5% and 3% in fiscal 2017, respectively. And, IoT applications hold even greater promise for Cisco moving forward.
The IoT is an emerging technology which promises to connect a range of devices, including household appliances, automobiles, and more. No longer will smartphones and tablets be the only devices with connectivity.
To quickly expand in IoT, Cisco acquired software maker AppDynamics for $3.6 billion. AppDynamics’ software is used in the financial services and retail industries, to boost their corporate networks. Cisco also acquired device connectivity software maker Jasper Technologies, for $1.4 billion.
With a 3% dividend yield, Cisco is an attractive pick for growth and dividends in 2018.
The Beauty of Best-In-Class Tech Stocks
Normally, investors are tempted to re-balance their portfolios at the end of each year, by selling their winners. This year, investors might be wise to hold onto their winners, especially those from the technology sector.
There could be further gains ahead for the best-in-class tech stocks like Apple, Microsoft and Cisco. All three companies are cash flow machines, and are sitting on mountains of cash that could be put to work in shareholders’ favor.
For all three tech stocks in 2018, investors can expect continued growth along with rising share buybacks and dividends.
Disclosure: The author is personally long AAPL.