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 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.