Value Added


Bargain Tech Stocks

Steven Goldberg

A decade after they began a mammoth collapse, technology stocks are cheap -- and growing.



A decade ago, the technology-laden Nasdaq Composite index closed at a record high of 5049. At the close on April 5, the index stood at 2430, still at less than half of its peak, even after surging 52% over the past 12 months. Over the past ten years, the average tech-sector fund has shed 57% (and that figure understates the devastation because it excludes the many funds that liquidated). Now that is a bear market.

But here’s what’s important. Over those ten years, most technology companies -- at least the ones that survived the carnage -- have grown rapidly. Consequently, you can buy some of these fast-growing companies at valuations that were unimaginable a decade ago.

Take Cisco Systems (symbol CSCO). In the fiscal year that ended July 29, 2000, the networking behemoth posted operating earnings of $2.7 billion, or 36 cents per share. At a split-adjusted price of $68.19 on March 10, 2000 (when tech stocks peaked), Cisco’s price-earnings ratio was 166. It traded at 28 times book value, 31 times sales and 92 times cash flow (earnings plus depreciation and other noncash charges). Of course, those were absurd, bubble valuations.

Today, I’d argue, Cisco’s stock is cheap, particularly when you consider the company’s growth rate. The shares closed at $26.17 on April 5. Analysts expect Cisco to earn $1.53 a share for the fiscal year that ends July 31. The stock’s P/E, based on that estimate, is 17. It trades at three times book value, four times sales and 16 times cash flow. Analysts expect the company’s earnings to rise an average of 12% annually over the next three to five years.

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Cisco is hardly unique. Almost all of the tech giants -- even glamour stocks such as Apple (AAPL) and Google (GOOG) -- trade at ho-hum multiples to earnings, yet they should post solid earnings growth for years to come. “Given the return on capital (a measure of profitability), it’s strange that they trade at the multiples they do,” says Dave Eiswert, manager of T. Rowe Price Global Technology fund (PRGTX).

Over the past ten years, these companies have hardly stood still. Many now have virtual monopolies or are part of duopolies in important tech businesses. Most are loaded with cash. In 2000, “Many companies were run fast and loose,” Eiswert says. “There was a lot of inefficiency, there was backdating of options, and accounting was often sloppy. They were run to grow fast and take advantage of Internet growth.” Over the past decade, “These companies have gone from fumbling hype, go-go-go to efficient, well-run companies.”

But investors don’t seem to care. Why? Hedge funds and other short-term investors who Eiswert says dominate trading treat tech companies as purely cyclical creatures. That is, they see businesses that worsen when the economy softens and grow back only to their previous peaks at the top of the next economic cycle. The classic way to trade such cyclicals is to buy them when earnings are awful and sell them when earnings accelerate. “It’s the old cyclical argument,” says Eiswert. “You sell when things are good.”

If the last few sentences make little sense to you, don’t fret. Most individual investors have no business trading stocks that way.

The irony is that during the tech-bubble years of the late 1990s, many investors posited that tech stocks were immune to economic cycles. They were seen as pure growth vehicles -- those that would produce rising earnings year after year no matter what was happening to the broad economy.

As subsequent events demonstrated, tech’s cheerleaders were badly deluding themselves. But to dismiss the growth potential of these companies is equally ridiculous. The global demand for technology will continue growing rapidly for the foreseeable future. Consumers -- not only in the developed world but also in emerging markets -- hunger for the next must-have gadget. Businesses must upgrade their technology to stay competitive and maintain and improve their profit margins. “Over the last eight or nine years, corporate customers haven’t spent a lot of money on technology,” Eiswert says. That will change.

I think there’s another reason tech stocks are cheap. It’s the old saying “Once burned, twice shy.” Nasdaq plunged 78% at the worst of the 2000–02 bear market, crippling investors. Nowadays, as Eiswert says, the conventional wisdom holds that “Tech is for chumps.”

The big risk for tech stocks is that the global economy stops growing. “Technology is leveraged to the global economy,” Eiswert says.

What to buy? Eiswert’s favorites include the aforementioned Apple, Cisco and Google, as well as Applied Materials (AMAT), JDS Uniphase (JDSU) and International Business Machines (IBM). His fund is a solid choice, too. It returned an annualized 9% over the past five years through April 1, putting it in the top 13% among technology funds. Expenses are 1.22% annually. But whether you buy individual stocks, Eiswert’s fund or a diversified fund with a big weighting in the sector, you won’t go wrong holding a healthy slug of tech in your portfolio.

Steven T. Goldberg is an investment adviser in the Washington, D.C., area.



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