Twelve years after the tech wreck, technology stocks and the ETFs that follow them are trouncing the market. In the first three months of 2012 alone, the Technology Select Sector SPDR (XLK) rose 18.9%, while the SPDR S&P 500 ETF fund (SPY) rose 12.6%.
Retail investors aren't the only ones piling in. A global money manager survey from Bank of America Merrill Lynch reports that overweighting by U.S. fund managers is higher for technology stocks than it is for any other sector.
For financial advisors, the 42 technology-focused exchange-traded funds tracked by Standard & Poor's make it a lot easier to tilt the scales toward technology stocks than it was when the group was burning rubber in the late 1990s. While there is certainly room for debate about whether that's a good idea, these ETFs provide an entry point to a group of stocks that are very different from their pre-21st century predecessors.
In 1999, the tech-heavy Nasdaq index was trading at 178 times trailing earnings, while it's at 12 times today. Many companies in the index were big-idea, small infrastructure start-ups born from the dot-com boom.
By contrast, the companies that dominate the market today, such as Apple, Microsoft and Hewlett-Packard, have been churning out rising earnings for years. They've weathered market downturns as well as, if not better than, the broader stock market. Many of them have excess cash flow and pay dividends.
"With large cash balances, increasing dividend payments, solid management and tight inventory controls, the tech sector is far more stable than it was in the last 1990s environment that so many still remember," says Brad Sorensen, Schwab's director of market and sector analysis.
Sorensen says the technology sector is the only group the firm covers that could outperform the rest of the market in the coming months. After holding back on capital improvements in the last few years, these companies appear to be spending again, and they will look to upgrade their technology first. Their excess cash leaves room to increase dividends and pursue mergers and acquisitions, while the companies' financial strength has given the stocks greater stability during market downturns than they've had in the past.
Despite the run-up in these stocks, some analysts believe there is still room for further appreciation. In a March report titled Tech-Well-Loved But With Good Reason, Bank of America research analyst Savita Subramanian noted that "tech valuations remain near their cheapest levels going back to 1995. At 12.8 times 2012 consensus earnings, tech is trading roughly in line with the market." Even excluding the tech bubble years, 1998 to 2001, the group's current price-to-earnings ratio is more than 30% below its historical average and well under its historical 24% premium to the market, she added.
But Subramanian also cited problems that could lead to short-term volatility in this group, which has a history of bouncing around more than most others. While technology companies have a strong presence in emerging markets, they derive an average of 25% of their revenues from the struggling euro zone. Government spending cuts could impact sales; and while a lower U.S. corporate tax rate would certainly help their bottom line, sectors that derive more of their revenue from sales in the U.S. would get a bigger boost.
The Apple Factor
Investors who think the sector could outperform the overall market might see buying opportunities in technology's periodic dips. But those pursuing that strategy by investing in technology ETFs should consider that the stocks already make up a significant portion of many broad-based indexes.