Michael Sola is a changed man. Three brutal years of declines have taught the manager of the largest tech fund, T. Rowe Price Science & Technology, a valuable lesson: The sector has become cannibalistic. Gone are the days when a new PC or cell phone was a gimme. "Five years ago, many American households didn't have a cell phone," he says. "Today, it's not uncommon to find four in one family." And if they have four, they probably don't need a fifth. So in order to thrive, tech companies must steal business and manage their costs effectively.
A LEARNING CURVE. Investing in this environment requires more patience, Sola has learned. Beaten-up stocks take longer to recover, and winners take longer to emerge. So he has lowered the fund's turnover ratio from 150% to about 60%. The buy-and-hold approach has worked well so far. Since Sola took over the fund from former manager Charles "Chip" Morris in January, 2002, the fund has beaten its peers, losing less last year and gaining more this year, up 14.7%.
But the learning curve has been painfully steep. During the 1990s, almost every tech manager believed demand for PCs, cellular phones, and microchips would just keep growing. By January, 2000, while Sola was an analyst at the fund, he and Morris were concerned about valuations. But their fund was lagging rivals, and they felt pressure to buy such Internet and telecom darlings as DoubleClick, Qualcomm (QCOM), and Ariba (ARBA). Big mistake. The then-$12 billion fund fell 34% in 2000 and 41% in 2001, trailing its peers in both years. Today, T. Rowe Price Science & Technology has only $3.2 billion in assets.
Sola now seeks "market-share gainers" that can thrive, or at least survive, during a slowdown. In the absence of growing demand for PCs, such companies are stealing business from other PC makers. "Dell Computer (DELL) (DELL) is a prime example of a share-gainer," Sola says. "Revenues grew 10% in 2002 in an environment where PC sales were down 2%." Dell does this primarily by making PCs more cheaply and efficiently than its peers.
In a sluggish economy, all companies want to cut costs. So Sola thinks software companies such as Mercury Interactive (MERQ) and Veritas Software (VRTS), which help manage and pinpoint problems in networks, databases, and servers, will also gain on rivals. "In the tech heyday, a company might have just thrown new hardware at a problem," Sola says. "But fixing a problem is often cheaper than building a whole new network."
CAUTIOUS OPTIMISM. Software makes up 18% of his portfolio, the largest sector, but Sola stresses that investing in broad industry groups doesn't work well now. "Everything is company-specific," he says. "Software application vendors such as Oracle (ORCL) or SAP won't necessarily generate the cost savings that Mercury Interactive and Veritas will."
He also has a 13% weighting in e-commerce stocks such as First Data and Fiserv, which process financial transactions. "These companies have consistent earnings growth, since electronic transactions have been increasing steadily for the past 10 years," says Sola. Both outperformed the tech sector during the bear market, but Sola says their moderate growth "won't have sex appeal" during a bull market recovery.
Sola knows that the most economically sensitive companies will perform the best during a recovery -- or in anticipation of one. That's why he has a stake in semiconductor stocks even though he's concerned about their growth prospects. "If the IT spending environment doesn't improve, I think semis could run into problems in the second and third quarters," he says.
Still, he owns shares of Analog Devices (ADI) and Maxim Integrated Products (MXIM), which manufacture analog microchips. They are used to measure real-world data in sensor devices, such as those that gauge how fast your car is going. Sola thinks the growth potential is better for such chips than the digital ones Intel produces to run computers.
He also has bought Cisco Systems (CSCO) and Microsoft (MSFT), companies that may not thrive in a continued economic downturn but will at least survive. "Cisco has demonstrated an ability to execute in a very difficult environment," he says. "It has managed its expenses so that even though it has had little revenue growth, it has delivered earnings growth."
Sola is encouraged by the recent performance of technology stocks, but he's hesitant to declare a recovery. "We're certainly closer to the turn than we were three years ago, but most people doubt every rally we have in tech now" can be sustained, he says. After so many rough years, this manager is determined to play it safe. By Lewis Braham