Investors who are smart-and cautious-can find opportunities.
Five years ago it practically was the market. Today,
it's more an enigma than anything else. The technology sector still has
a ways to go before it regains the trust of the investing community.
The scars from the bear market are still a bit too fresh, with the
sector's continued volatility providing investors with almost a daily
reminder of what could happen to an overly indulgent investor.
Since the sector's pinnacle in March 2000,
technology fund investors have endured five-year annualized losses of
16%. Although the sector has rebounded somewhat the past three years,
particularly in 2003, technology funds are on track for a flat finish
in 2005.
On an overall basis, the technology sector looks pretty dead.
"It has been a real treacherous part of the market,"
says Karen Dolan, a mutual fund analyst at Morningstar. "For most of
these funds, their five-year numbers are still in negative territory."
But analysts and money margins do point out that the
technology sector encompasses so many subcategories and businesses-to a
degree that it may be inadequate to describe technology as a
"sector"-that it behooves investors to be involved to some degree.
That is probably one of the reasons that growth
managers, despite all the volatility and negative buzz, still maintain
science and technology as about 25% of their holdings, says Andrew
Clark, a senior research analyst at Lipper. For core funds that mimic
the S&P 500, science and technology makes up about 15%, he adds.
"The only reason I can think of for why they're doing it is that there
are a lot of closet indexers out there," Clark says.
Some observers say that, as with any stock, finding
suitable technology holdings is possible with the appropriate research.
Mark Mowrey, senior analyst at Al Frank Asset Management and editor of
the firm's technology newsletter, says the firm has about a 70% success
rate when it comes to picking technology purchases.
Finding winners, however, isn't easy. While some
argue that technology stock prices have sunk to the point of
undervaluation, Mowrey cautions that assessing the future
earnings of a technology company can be tricky.
"Some stocks look attractive but they're really priced where they
should be priced," he says. "They should be cheap because their
technologies don't have the legs to keep them viable over the long
term."
Keeping competitive, Dolan says, is among the
sector's chief problems, as competition-both domestic and
overseas-makes it hard to maintain profit margins over the long haul. A
breakthrough hit one year could be a commodity a year or two later,
with profit margins wiped away by competition, she says.
Even the iPod, the portable music device that
transformed Apple from a computer maker to a thriving consumer
electronics company, is on the verge of being challenged by a wave of
newer and cheaper products, she says. "They have tough challenges to
their business models and those aren't going away," Dolan says.
While high volatility is the reason some investors
are wary of technology, it's also one of the things that draws
investors in. Investors still view technology as an area that can
provide huge payoffs with the right picks.
That's the attitude that led to the feeding frenzy
in the 1990s and which, despite the technology crash of March 2000,
continues to occasionally show itself-such as it did with the public
offering of Google last year. "I think there is always that sexiness in
technology that drives people to invest in it," Mowrey says.
He doesn't expect that fervor to diminish as
generations of the school children who grew up with computers and other
high-tech gadgets become investors themselves. "Folks my age lived with
(computers), and it's getting to the point where we are becoming a
major portion of the investing public."
But fervor aside, investors who consider themselves
sober in regards to technology say good investments can be
cherry-picked. Among the sectors mentioned as potential harvesting
areas are consumer electronics, semiconductors, data storage and
communications.
Jay Wong, principal of Los Angeles-based Payden
& Rygel and manager of the U.S. Growth Leaders Fund, says he is
bearish on the technology sector in an overall sense, yet has
individual tech stocks among his holdings. "As bottom-up stock pickers,
there are always going to be opportunities, regardless of the sector,
to cherry-pick the best companies," he says.
One of his primary concerns regarding technology is
that there has not been an upturn in capital spending. Technology
companies have built up a lot of cash, he says, but they have opted to
put it toward dividends and buybacks. "Corporate America continues to
be cautious," he says.
Yet there are areas that he likes. His fund owns
Motorola, which he feels is in a good position as it gets ready to roll
out a product to compete with the Blackberry wireless e-mail messaging
system. He also owns Apple, which he feels will benefit as it expands
into entertainment content-something he feels will complement the iPod
and its other electronic hardware products.
The semiconductor sector is another area Wong is
watching. He likes Freescale Semiconductor, which was spun off by
Motorola and now is focused on making computer chips for phone
manufacturers.
These are also examples, he says, of large- cap
companies whose prices have endured the ripple effect of the entire
sector's decline. "The sector was suffering from overvaluation and now
we're at the point where you can say things are starting to look
attractive," he says.
Mowrey is also looking at communications and
semiconductors, as well as the data storage sector, which he feels will
be a beneficiary of a demand for storage across many industries.
Companies such as Western Digital and Seagate will see "significant
demand growth" as both consumers and businesses look for expanded
storage devices to holder their e-mails, video and music files and an
assortment of other data.
Semiconductor companies, he says, are similarly well
placed "because we see chips making their way into every single thing
we use. I wouldn't be surprised if pens have chips somewhere down the
line," he says.
In the communications area, he likes cable
television companies more than he does telecommunication companies,
even though he feels in three or four years the two categories will be
indistinguishable from one another in terms of the services they
provide. Cable television companies have a leg up, he says, because
they have already laid down the networks and infrastructure necessary
to provide a wide array of broadband services to consumer's homes.
Telephone companies also have wires to the home, but
they are largely copper wires that weren't originally designed for
broadband service delivery. The telecom sector is in the midst of
upgrading its networks with fiber optic cable, but they're lagging
behind cable television companies, he says. "They have bigger pipes and
they have spent that money already," he says of the cable television
industry.
Unlike many other analysts, Mowrey isn't high on
Google, which is trading at nearly $400 per share-up from $161 earlier
in the year and its $85 IPO price in 2004. "As it shot to $300, I was
at a loss for understanding what folks saw as the long-term potential
for what Google does," he says.
He feels that Google is an example of some of the
dot.com mania of the 1990s repeating itself, with investors justifying
high valuations with dubious reasoning, While he believes that Google
is a successful company, he feels investors have entirely discounted
the impact competition will have on the company.
"Folks have priced perfection into Google's behavior and competitive
success," he says. "But competitors aren't going to allow Google to
just keep continuing to have its way in any space."
(Two weeks after Mowrey was interviewed, the news
media reported on a leaked memo in which Microsoft founder and Chairman
Bill Gates rallied his troops against competitive threats in the
Internet-based software arena. The memo was viewed as a signal that
Microsoft plans to compete more aggressively with companies such as
Google and Yahoo!).
Even with the hype surrounding Google,
however, Mowrey doesn't see a return to the type of boom that was
seen in the late 1990s. "When folks say, "When is tech going to come
back?" I don't think we will see this wholesale shift into technology
like we did in the 1990s," he says.
Dolan of Morningstar says that probably the best way
for an investor to get into the technology sector is through a growth
fund, given the fact that the tech sector is well represented in their
portfolios. Investing in a technology fund-there are currently about
114 funds of this type in the nation-would be a more aggressive and
riskier move, and she warns that anyone taking this route should check
the holdings of their other funds to get a true picture of how heavily
they are invested in technology.
"If you're putting money in a tech fund you need to
make sure you know why you're doing it and how much technology you have
in the rest of the portfolio," she says.