SECTOR INVESTING

Don't give up on tech stocks

You can now pick up stocks that are Tiffany merchandise at Kmart prices. But limit your tech exposure, experts advise.

By Leslie Kane
Senior Editor

The legendary phoenix that rose from ashes may have nothing on tech stocks. "The outlook for technology remains strong," says Marc Singer, an investment adviser with SingerXenos Investment Management in Coral Gables, FL. "The Internet continues to change the world, and the communication infrastructure will continue to grow. Tech will be a robust market sector, although I don't expect its stocks to hit their previous heights anytime soon.

"In the tech bubble of 1998-2000, the market priced tech companies as if they were going to double and triple every year," says Singer. "It's more likely that going forward, tech will return 12 to 14 percent annually—better than the Standard & Poor's 500 historical annualized average of about 11 percent."

The tech sector began its dive as corporations cut technology spending. Manufacturers and suppliers wound up with inventory gluts. Revenues slowed, and since overexuberant investors had bid up the stock prices too high, shares plunged. The PSE Technology Index's total return was about 116 percent for 1999. But by Oct. 31, 2001, it was –26.47.

"Many of the factors that led to the sector's decline are correcting themselves, and it's likely that technology will climb again," says Michael Murphy, editor of the California Technology Stock Letter in Half Moon Bay, CA.

"The recent federal interest rate cuts will encourage spending," says Murphy. "Inventories will decline. New, more efficient products will prompt businesses and consumers to replace aging computers. Companies will automate more operations to increase efficiency."

America's new focus on security will also play a role. "More companies want to keep data backed up at secure, remote locations," says Murphy. "Security and military electronics will gain increased attention." If vacation travel declines, consumers will likely invest more in electronics and home-entertainment technology.

The turnaround could take a while, however. "September's events will delay our economic rebound. Tech will start to rise again sometime between the second and third quarters of 2002," says Singer. "As soon as it starts recovering, prices will go up quickly."

You now have the chance to grab some tech stocks that are Tiffany merchandise at Kmart prices. But be careful. "Just because a stock is down 90 percent doesn't make it a buy," cautions Patrick Dorsey, director of stock analysis for Morningstar.com, an investment research and rating firm.

Key in on established companies with sound financials, strong market share, and new products in the pipeline. "Solid companies have the size and flexibility to make adjustments in their workforce, and have enough cash to fund innovative products and growth opportunities," says Murphy.

Evaluate your current holdings before you add tech stocks. "Keep your tech exposure below 20 percent," says Mary McGrath, a financial planner and portfolio manager in Champaign, IL.

Invest in tech slowly, she adds. Put in a fixed amount each month (that's called dollar-cost averaging) so that you buy shares at various prices. And keep a long-term perspective; don't let market gyrations scare you into yanking your money out.

The tech companies profiled here all are in excellent financial health and are market leaders. Michael Murphy and Patrick Dorsey believe they'd be wise choices to snap up now.

• Dell Computer. "If you buy one PC stock, buy Dell," says Morningstar's Dorsey. The world's largest direct-sales computer systems company, Dell sells hardware, software, and related services, mostly via sales teams to reach corporate and institutional customers, and through telephone and the Internet to consumers. Its 12-month sales through October topped $32 billion. The company, located in Round Rock, TX, has blown past Gateway, Compaq, and other competitors.

"Among low-cost producers, Dell is the one to beat in the PC market, which competes on price rather than on unique features," says Dorsey. Since it doesn't supply retail stores, Dell is able to keep minimal inventory. Its relatively low overhead allows Dell to cut prices and boost market share when computer hardware sales slacken. The company plans to streamline operations further to maintain profits.

To conquer new markets, Dell has begun to aim its direct sales approach at the server/storage systems arena. The company also plans to focus on overseas growth and higher-end, more profitable products.

• EMC. Right place, right time was the success formula for EMC. If your hospital stores backup data at a remote location, chances are it uses the services of EMC, in Hopkinton, MA. The company is the dominant player in the data-storage hardware and software market.

Internet growth is driving up demand for data storage 80 percent per year; EMC commands 35 percent of the high-end storage realm, and is geared to supply that market. In 1999, it acquired Data General, which concentrated on midpriced storage, so EMC is ready to broaden its market coverage. It is also targeting the networked storage market, a rapidly growing segment, and is giving an extra push to software sales, since software margins tend to remain firm. The company's sights are set long term. Despite slowing sales throughout 2001, it invested $1 billion in research and development. "Storage will be one of the first technology sectors to rebound when the economy recovers," says Dorsey.

• Intel. It's the 800-pound gorilla that plans to stay atop its domain. The $28 billion semiconductor manufacturer controls more than 80 percent of the PC chip market. Intel's now in a funk, mostly due to slow demand and inventory buildup, but its huge size and scale give it a major advantage over rivals.

The company's pumping $300 million into promoting its new, faster version of the Pentium 4 chip, and it expects reinvigorated sales growth. Intel's Itanium, a high-end server chip now used only for commercial applications, will begin powering desktop PCs in about two years and will provide a superior product.

Plus, Intel's forging into new growth arenas, such as wireless communication and networking. Knowing that innovative products are its lifeblood, the company continues to invest in research and development, devoting $7.5 billion to capital equipment spending this year. "Intel's research and development will keep it in the forefront of the sector," says Murphy.

The company, based in Santa Clara, CA, has a venture-capital unit that maintains relationships with emerging technology firms. That often gets it in on the ground floor of new developments.

• Linear Technology. No need to slug it out in the price-war trenches. Linear Technology, in Milpitas, CA, designs and manufactures high-end analog chips used in telecommunication equipment, computers, video equipment, industrial controls, automotive systems, and satellites. The circuits monitor, modify, or transfer continuous signals from instruments that measure temperature, light, speed, and sound. The firm's expertise in designing analog chips is a big barrier to competitors jumping in. And since Linear Technology's products are proprietary, competition seldom influences its pricing. So, unlike commodities, whose prices are driven by simple supply and demand, Linear Tech's products remain reasonably expensive. The company attracts top design engineers, which will help retain its leadership position.

Linear Technology is likely to withstand an economic slump better than other producers of similar chips, mainly due to tight cost controls, superior products, and experienced management. Sales have increased in each of the past 10 years, which is rare in a cyclical industry. In addition, the analog niche has long product cycles and is less volatile than other chip segments.

• Microsoft. For many, Microsoft remains the symbol of mind-blowing investor profits. Its best growth is probably past. But as the largest independent software maker, the Redmond, WA, firm is still worth buying.

"Microsoft's Windows XP operating system, recently launched, will ignite a spending spree," says Murphy. "More than half of the estimated 240 million Windows users will upgrade to XP in the first year alone." The new system, available for PCs and businesses, runs much faster than current Windows software. Bill Gates and other company honchos are also pinning hopes on the company's Xbox gaming console, launched in November 2001. It enables designers to create new levels of game graphics.

Another big thrust is the company's .NET strategy, which includes developing tools and applications that deliver services to PCs, PDAs (personal digital assistants), and other devices via the Internet.

"One reason I favor Microsoft is that its accounting is very conservative," Murphy says. "It keeps big reserves. It also takes the conservative approach to forecasting sales. If a product launch is delayed, or sales don't kick in as fast as anticipated, Microsoft's bottom line wouldn't suffer much." Microsoft's antitrust battle may be winding down. The worst potential consequence—a breakup of the company ordered by the trial judge last year—was thrown out of court.

• Nvidia. Is it a blessing or a curse that kids sit entranced by computer game graphics? Whatever your view, you probably have Nvidia to thank or blame. It's the leading developer of 3D graphics, multimedia processing technology, and related software used in personal computers and gaming consoles.

The recognized superiority of Nvidia's products has crushed most of its competitors. Nvidia's many customers include Microsoft, HP, and Dell. The $20 billion annual videogame industry will keep product demand high.

Nvidia, in Santa Clara, CA, supplies two key processors to Microsoft's Xbox gaming console. If the Xbox is a wild hit, Nvidia's sales growth rate could top 40 percent a year or more. Even if the console's a dud, the company's sales growth is still expected to reach 20 percent.

Tech stocks that still look strong

If you'd rather invest in mutual funds, see "Technology mutual funds spread your risk".

Technology mutual funds spread your risk

If you prefer having professionals make the choices for you, stick with mutual funds.

By Leslie Kane
Senior Editor

Don't be scared off by most funds' grim recent returns. Portfolios are just starting to limp back from the tech wreck.

Only about 52 of the 378 technology funds tracked by Morningstar have been in existence for five years. That's an important watermark, since you want to gauge a fund's performance prior to the meteoric sector rise of 1998 to early 2000.

Besides looking at returns, stick with a fund from a large company. "These firms have scores of analysts researching technology stocks, which should provide portfolio managers with a competitive edge," says Christine Benz, an analyst with Morningstar. Smaller companies may not be able to cover the field adequately.

These five funds have the track record, quality of research and analysis, and management experience to strengthen your portfolio.

• Alliance Technology Fund. A conservative technology portfolio is not an oxymoron. This low-turnover fund spreads its bets across many tech sub-sectors, including semiconductors, software, and computer services. Its managers avoid speculative stocks, and stick with established names like First Data, AOL Time Warner, and Microsoft. Fund managers look for rapidly growing firms that dominate their niche, and they usually hold on long term.

First Data has been a top performer recently, returning about 38 percent year-to-date, despite the sector dive.

The fund's volatility is among the lowest in the tech sector. Turnover's way below average, too, making the fund highly tax-efficient. And its managers are high on experience, each having chalked up more than nine years with the portfolio.

• Dresdner RCM Global Technology Fund. "With so many technology funds launched in the last five years, it was amateur hour in the tech-fund sector," Benz says. "We learned that it pays to go for a team of pros like the ones who run this fund." Portfolio managers Huachen Chen and Walter C. Price have been running technology portfolios for 10 years, and have been in charge of the Dresdner RCM Global Technology Fund since 1999.

The fund is a prime choice not only for its top returns, but because it cuts across many technology sectors and company sizes, and avoids initial public offerings. "The managers are supported by a crack in-house research team as well as grassroots researchers hired on a per-project basis," Benz says. One of their smartest choices was Siebel Systems, in San Mateo, CA, a company that makes sales- and marketing-information software systems. Although many corporations have cut software budgets, demand for customer-relationship software has remained high, and sales have doubled in each of the last four years.

Initially an institutional fund, Dresdner RCM Global Technology Fund recently opened a share class for individual investors.

• Fidelity Select Technology Portfolio. Prior to this year, top returns have been this fund's hallmark. It owns about 100 stocks, giving it extensive reach. Most technology funds own fewer than 100. "Its scope is broader than that of Fidelity's other technology funds, allowing its manager to invest in any tech sector," says Benz. A move back into Microsoft this spring helped boost returns, since the software giant has fared much better than most technology stocks so far in 2001. Despite frequent manager changes, the fund has posted a strong record.

One company that has done well for the fund is Computer Associates International, which markets software for mainframe and distributed systems. The stock has returned about 57 percent year-to-date.

The fund's 1.0 percent expense ratio is noticeably below the technology fund average of 1.7 percent.

• Invesco Technology Fund. Look here for a steadier performance than you'd get from the typical tech fund. Portfolio manager William R. Keithler has made some savvy picks that brought in strong returns. He also spreads the fund's assets across a broad range of companies, keeping a small—and nearly equal—percentage in each. That prevents any individual stock flop from dragging the portfolio down.

The Invesco Technology Fund avoids betting heavily on a handful of names. Although Keithler tends to focus on small technology companies, diversity keeps his fund from taking wild swings. One small business that's done well for him is Lam Research, which makes equipment used in the production of semiconductor devices. Lam's sales were up 90 percent from 1999 to 2000.

• North Track PSE Tech 100 Index Portfolio. This could be your easiest bet for technology. The fund tracks the PSE Technology Index, which stood up better than most technology mutual funds. The index is price-weighted, which means relatively small companies can have more impact on the fund's performance than some much bigger companies like Cisco Systems, which has a lower share price. That gives the index a small-cap bias, as well as diversification. Those factors have brought the fund above-average returns in the tech sector, as well as below-average volatility.

One noteworthy holding is Electronic Arts, the world's largest interactive entertainment software producer, located in Redwood City, CA. Its share price has climbed throughout the overall tech collapse.

Tech funds with good track records

 

Leslie Kane. Don't give up on tech stocks. Medical Economics 2001;24:29.