XLK Technology Select Sector

The technology sector has been worst hit of late on lofty valuations and forewarnings of soft earnings. This trend is likely to continue at least in the near term with disappointing Q1 results from International Business Machines (IBM), the largest computer-services provider.

This has also heightened worries over the other traditional computing giants like Oracle (ORCL), Cisco (CSCO), EMC Corp. (EMC) and Hewlett-Packard (HPQ), which are expected to report this month or in the next. This is because enterprise spending has been on the decline, and corporations and governments are embracing software-as-a-service (SaaS) and other cloud offerings instead of in-house technology infrastructure.

IBM Results in Focus

The missing trend for revenues continued for this tech giant for eight consecutive quarters. Revenues dropped 4% year over year to $22.48 billion, and fell shy of the Zacks Consensus Estimate of $23.01 billion and represents the lowest quarterly revenue in five years. Earnings per share of $2.54 met our estimate but fell year over year for the first time in 11 years.

Sluggish demand for computer hardware and weak sales in emerging markets, including China, Brazil, Russia and India, were the major culprits of the dull performance (read: Emerging Market ETFs See Inflows: 3 ETFs to Pick).

The company is transforming its traditional business to strategic growth areas including cloud computing, Big Data analytics, social, mobile and security. However, it will take years for the company to reap full benefits and boost growth.

Despite the lackluster Q1, IBM reiterated its earnings per share outlook of at least $18.00 for the full fiscal year. Though this is slightly higher than the Zacks Consensus Estimate of $17.92, the disappointing top line continued to dampened investor mood. As a result, IBM shares fell about 4% in after hour trading yesterday.

This has raised questions on the company’s revenue growth story, leaving investors feeling bearish about this stock for at least in the near term. Further, IBM currently has a Zacks Rank #4 (Sell) and a poor industry Rank (in the bottom 36%) at the time of writing as per the Zacks Industry Rank, suggesting that more pain could be in store for this company in the near term.

ETFs to Watch

The uninspiring results could have a huge impact on tech ETFs that are heavily invested in this large company. Below, we have highlighted three ETFs with the highest allocation to IBM that could be in focus in the days ahead (see: all the Technology ETFs here).

Investors should closely monitor the movement in these funds and could catch the opportunity from any surge in the IBM price, or avoid them if the stock drags them down in the coming months:

First Trust NASDAQ Technology Dividend Index Fund (TDIV)

This fund provides exposure to the dividend payers within the technology sector by tracking the Nasdaq Technology Dividend Index. The product has amassed about $465.9 million in its asset base while trades in volume of more than 133,000 shares per day. The ETF charges 50 bps in annual fees (read: 3 Excellent Dividend ETFs for Growth and Income).

In total, the fund holds about 89 securities in its basket. Of these firms, IBM takes the second spot, making up roughly 8.33% of the assets. In terms of industrial exposure, the fund allocates one-fourth portion in semiconductor and semiconductor equipment, followed by software (15.65%), and technology hardware, storage & peripherals (14.92%). The fund has returned nearly 2.4% so far this year.

iShares Dow Jones US Technology ETF (IYW)

This ETF tracks the Dow Jones US Technology Index, giving investors exposure to the broad technology space. The fund holds 143 stocks in its basket with AUM of $3.8 billion while charging 46 bps in fees and expense. Volume is moderate as it exchanges nearly 380,000 shares in hand a day. Of the major holdings, IBM takes the third position in the portfolio, making up 6.59% of asset.

More than half of the portfolio is skewed toward the technology hardware and equipment segments while software & computer services take the remaining portion in the basket. The fund is up 1.7% in the year-to-date time frame and has a Zacks ETF Rank of 3 or ‘Hold’ with a ‘Medium’ risk outlook.

Select Sector SPDR Technology ETF (XLK)

The most popular technology ETF on the market, XLK follows the Technology Select Sector Index. This fund manages about $12.2 billion in asset base and provides exposure to a small basket of 73 securities. The ETF charges 16 bps in fees per year from investors while trades in heavy volume of more than 7.7 million (read: Technology ETFs: Pain or Gain Ahead?).

Here, IBM is the fourth firm in the fund’s holdings with 5.55% allocation. In terms of industrial exposure, the product is widely spread across technology hardware storage & peripherals, IT services, software, Internet software & services and diversified telecom services that make up for double-digit allocation. The fund has added nearly 1.38% so far this year and has a Zacks ETF Rank of 3 or ‘Hold’ with a ‘Medium’ risk outlook.

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