One sector of tech is looking a little frothy.
Names in the U.S. software sector, led by prominent tech players such as Action Alerts Plus holding Micrososft (MSFT) and Salesforce (CRM) , has enjoyed an average 23% share price pop year to date. The relative out-performance to the Nasdaq Composite has been fueled by a combination of impressive fourth quarter results and M&A speculation. Robust cash hoards, and how they will be spent under the new tax reform plan, has also helped boost investor sentiment.
The major problem now is that the sector may have gotten too far out front of itself from a valuation perspective.
Software valuations previously peaked at 6.3 times in March 2014 on an enterprise value to sales ratio, and again at 6.3 times in June 2015, according to UBS. The group has now broken through that level, at an average multiple of 6.7 times currently. UBS notes the most significant appreciation has been in the lower tier of valuations, with the 25th percentile of multiples now 48% above the historical mean.
The most expensive stocks are valued 33% above the seven-year mean on an enterprise value to sales ratio basis.
Says UBS, "The spending environment remains robust and we don't see an obvious catalyst driving multiples lower in the near-term. However, we also see less opportunity for broad additional multiple expansion across the group from here."
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