Are there prospects for these 3 IT stocks?

With the domestic IT industry still in the doldrums are there opportunities in this sector?

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Integrated Research Limited (ASX: IRI) develops and implements the well regarded Prognosis performance monitoring system. The recently released Prognosis 10 is cloud enabled, and offers advanced real-time analytics and detailed historical reporting. Targeted sectors include Unified Communications, Payment Systems and IT Infrastructure.

With many big name customers (international banks, stock exchanges and major corporations), Integrated Research is unusual in that 95% of revenues and 42% of costs come from outside Australia. In a recent profit upgrade the company noted the benefit of a substantially lower dollar in addition to a positive outlook for Prognosis 10.

Debt free, Integrated Research is well funded and continues to focus on organic growth and the development of complementary products. Net return on equity hovers around 35% and 2014 earnings per share are estimated to be at least 7c, with a partly franked dividend of 5c. At $1.15, this places Integrated Research on an undemanding 2014 earnings multiple of 16.4.

I sold out of Technology One Limited (ASX: TNE) some time back as I felt it was becoming overpriced. This was despite the company fulfilling some of my essential criteria – significant management shareholding, superior product / service, low borrowings, disciplined growth path and so on. Naturally, the share price rose another 30% soon after my selling.

The beauty of Technology One is that it develops, installs and maintains its own suite of integrated enterprise software products. No agents and no licensing deals. This ensures a close and ongoing relationship with clients and a high retention rate. Clients include business, government, health and community organisations, financial services, utilities and education.

Although the overwhelming bulk of business is done in Australia, Technology One is attempting to break into the potentially lucrative UK market – without much success (only 13 customers after five years).

For the past 25 years Technology One has invested an average 15% of revenues into research & development (fully expensed). The company has indicated it is now in a position to reduce this expenditure to 8% of revenues over the medium term which will lead to net margin improvement. In addition, the gradual migration of some clients to the cloud will yield further cost savings.

Net return on equity stands at 45% and the estimated 2014 price to earnings ratio is 23, with a 2.7% mostly franked dividend. Although double-digit earnings growth can be expected over the next few years (due to the costs of doing business being reduced), it still looks expensive to me.

SMS Management & Technology Limited (ASX: SMX) is effectively a proxy for the IT services sector. With offices in Australia & Asia, this company is a well-managed business specialising in consulting, systems integration and technology. A current focus is the further development of managed services.

The IT industry has been in the doldrums for some time and continues to be affected by the capital cutbacks occurring in telcos, government and resources. On present indications profits in the IT sector are likely to fall over 2014, pushing out any hope of a recovery until 2015.

Currently priced at $4.22, SMS Management is selling at 18 times 2014 earnings and a 4.7% fully franked dividend – I would prefer to wait for $3.80 to appear before considering any purchase.

Foolish takeaway

All three companies are exceptionally well managed and each has carved out a viable profile in its field. However Integrated Research is the only one with substantial global reach and the positioning to capitalise on this. With the domestic IT industry showing little sign of any recovery, both Technology One and SMS Management & Technology are not present buys – however both remain on my personal watch list.

Motley Fool contributor Peter Andersen owns shares in Integrated Research

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