The reason for this summer exuberance is my growing conviction that the European Central Bank will in the weeks ahead do what a central bank should have been doing all along - take action to stabilise the sovereign debt market of Italy and Spain. This would involve buying the bonds of those countries in the secondary market on such a scale that short sellers would be left running for cover. It would also have the dramatic impact of forcing up prices and significantly reduce the mark-to-market losses facing financial institutions and banks on their bond holdings.
This is not wishful thinking, either. There is growing political backing for the so-called 'Draghi Plan' of "unlimited open-market operations" in the euro sovereign bond markets. The Finnish and Dutch are firmly onside, as is Germany's member on the ECB's executive board. It now looks as though German chancellor Angela Merkel will soon be in a minority. She'll also be powerless, since the ECB's priority, backed by its mandate, is to mitigate the risk of a euro break-up at all costs. We also have time on our sides for this big bazooka to be launched, as Madrid is funded through until October so has no immediate financing needs over the coming months.
In the circumstances, it's hardly surprising that there has been a sea change in investor sentiment following the ECB's president Mario Draghi's announcement at the end of July to "do whatever it takes" to preserve the euro. That's also why we have seen a sharp rise in risk assets in recent weeks and no more so than in the tech-laden Nasdaq 100 in the US, which formed a significant triple-top breakout on its point-and-figure chart on Friday 3 August. This price action looks fully justified since any decisive action by the ECB would at a stroke reduce the risk premium embedded in equity market valuations.
Consequently, I believe the US tech sector could be in for a very strong upwards move, so I want to be exposed to a company that will not only ride off the market's coat tails, but one that has a very good chance of leading the charge.
Imagination a smart tech investment
It was difficult not to be impressed with the full-year results from chipmaker Imagination Technologies (TIDM: IMG) at the end of June. Rapid growth in the smartphone and tablet market is proving a boon for the company, which grew pre-tax profits by over a half to £36.8m on a 30 per cent increase in revenues to £127m in the 12 months to end-April.
Shipments increased by a third to 325m chips, up from 245m in the previous financial year, driven by new products and, with the benefit of industry-leading designs, royalty rates are being maintained to protect Imagination's enviable underlying operating margins of 40 per cent. This heady rate of growth shows no sign of slowing as Imagination, which has 60 chip designs in production and no fewer than 76 in development, is ideally placed to benefit from high activity levels in the SmartTV market and growth in the smartphone market.
In fact, Imagination's managers believe they can treble shipments to around 1bn by 2016 based on a 50 per cent share of the 1.5bn units-per-year smartphone market through contracts with Apple, Android manufacturers such as MediaTek and Samsung, Intel+ and Arm. Tablets will also underpin future growth, while market share gains in the SmartTV and set-top box markets are likely - especially as the company is seeing growing licensing in China.
Imagination's valuation
Based on 10 per cent annual growth in licensing revenue and 30 per cent annual growth rate in royalty income over the next three years, analyst Alex Jarvis at brokerage Peel Hunt expects the company's pre-tax profits to more than double to £80.9m by the end of the 2014-15 financial year. This is based on revenues of £230m, up from £127m in the year to April 2012. On this basis, EPS will also double to 22.5p in the three-year period. So, although Imagination shares, at 538p (10am on Thursday, 9 August), trade on an eye-watering 48 times historic earnings, this would drop to a more sensible 23 times those April 2015 estimates. That's high, but not necessarily out of sync with the valuations of US competitors.
But this medium-term potential is not the main reason I am recommending buying them right now. My time horizon here is far shorter. That's because I can see Imagination's shares getting an immediate boost from newsflow over the coming weeks on the back of the iPhone5 launch next month as well as from a general market rise during which tech stocks should do rather well.
Interestingly, the shares gave a buy signal on their point-and-figure chart when the price closed above 520p. From my lens, a multi-week base formation has now been formed, which should launch the shares significantly higher in the weeks ahead. My target price range is 620p-640p, which would take the share price back to the support level that gave way in early May.
