IT Stocks with a Brighter Gleam

Even though 2005 hasn't been a stellar year for info tech, S&P's Scott Kessler still finds 18 strong buys

Information-technology stocks may have trailed the broad market so far this year, but some attractive names can still be found. That's the report from Scott Kessler, Standard & Poor's group head of the analysts covering IT stocks, who is guardedly optimistic about the rest of the year.

"We aren't ragingly bullish right now, in light of concerns about economic strength, technology spending, and seasonality," Kessler says. However, he does like some info-tech stocks, both for quality and what he calls "secularity" -- which he defines as "companies whose businesses determine the growth and aren't necessarily reliant on a strong economy or tech spending for revenue and profit increases."

Based on those criteria, Kessler lists 18 info-tech stocks as strong buys in the S&P rankings, including familiar names such as Cisco Systems (CSCO ), Dell (DELL ), EMC (EMC ), and Microsoft (MSFT ).

These were a few of the points Kessler made in an investing chat presented on June 14 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow (AOL subscribers can find a full transcript at aol.businessweek.com/chat):

Note: Scott Kessler is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

Q: How are the info-tech names doing relative to the rest of the market?

A:

Year-to-date through June 10, the S&P 1500 information-technology sector fell 4.7%, vs. a decline in the S&P composite 1500 of 0.8%. So, through the middle of June, technology stocks have underperformed. The stocks have shown signs of life in recent weeks, and we believe there's a chance that the performance gap can continue to narrow.

Q: What accounts for info tech doing so much less well than the broad index up to June 10?

A:

Well, we're only talking about a few hundred basis points. But nonetheless, the sector has trailed. We believe much of this reflects sector rotation into better-performing areas, such as energy and utilities. We also think there have been concerns relative to a variety of technology subindustries, whether it's inventories in the semiconductor-related segments or IT spending strength for software companies.

Sentiment, up until recently, had been extremely negative. But as indications of improvements in underlying fundamentals have manifested themselves from the likes of Intel (INTC ) and Texas Instruments (TXN ), we have noted that sentiment has benefited, as have shares of technology companies.

Q: What's your opinion on Google (GOOG ), long and short?

A:

Our opinion on Google since June 1 has been hold. Prior to that, we had a buy recommendation on the stock since mid-January. Our downgrade reflects the appreciation in the shares since last August's IPO, as well as notable gains year-to-date. We still think Google is a very good company, taking advantage of technology and advertising opportunities.

We believe Google's stock performance will be more "normal" in the coming months. We also think the competitive challenges the company faces in its core and emerging businesses are being underestimated perhaps. At this point, we actually like Yahoo! (YHOO ) as a buy recommendation, in part, because of the company's better diversification.

Q: Do you see Microsoft (MSFT ) moving out of the $25 range?

A:

We hope so, given our strong buy recommendation and 12-month target price of $33. We believe Microsoft is poised to benefit from solid growth in PC, and particularly notebook, sales around the world, as well as multiple forthcoming product cycles. We see the stock as undervalued relative to the company's market leadership and strong balance sheet.

Q: What do you think of IBM's move to China?

A:

I assume you're referring to IBM's sale of its PC business to China's Lenovo. We believe this was an interesting way for IBM (IBM ) to approach the Chinese market. Note that they retain a stake in that particular business. Just today it was reported that Lenovo is considering a separate PC brand for India.

Nonetheless, we believe that one of the motivations for this move was to deemphasize the PC business, which historically has offered less growth and profitability than some of IBM's other areas of emphasis. We actually see the recent Lenovo transaction, coupled with ongoing, or seemingly ongoing, changes at Hewlett-Packard (HPQ ), as aiding Dell (DELL ) as it pursues large corporate customers and contracts. Our recommendation on Dell is strong buy. Our 12-month target price is $49 a share.

Q: On IBM, what's the S&P ranking on its stock now?

A:

Our recommendation on IBM is hold. We see the stock as reasonably valued, owing to a blend of intrinsic and relative analyses. Our 12-month target price is $87.

Q: What's your take on EMC (EMC )?

A:

Now those are my kind of letters -- EMC is one of our favorite stocks. Our recommendation is strong buy. Our 12-month target price is $21. This reflects intrinsic and peer valuation considerations. We're definitely emphasizing providers of storage technology as a predominant theme underlying our tech sector strategy. EMC, we think, is doing quite well as it focuses on the concept of information life-cycle management, also known as ILM.

We think EMC is not only the biggest but also the best player in the storage category, particularly because of shrewd acquisitions made in the software segment over the past few years. These businesses have gained market share and aided company profitability. We think EMC is a core technology holding.

Q: How do you like telecom chip stocks like Vitesse Semiconductor (VTSS ) or Transwitch (TXCC )?

A:

We don't cover either of those companies. We do, however, cover some of their peers. By and large, we're neutral on them. Names we cover in that category include Applied Micro Circuits (AMCC ), RF Micro Devices (RFMD ), and TriQuint Semiconductor (TQNT ).

An alternative to these smaller, more speculative semiconductor companies that we recommend is stocks of high-end analog companies such as Linear Technology (LLTC ) and Maxim Integrated (MXIM ). Both have some exposure to the segment and are ranked strong buy.

Q: Your opinion on InfoSpace (INSP ), please, and VeriSign (VRSN ) and ValueClick (VCLK )?

A:

I can help you with two of those -- I actually cover both of the stocks beginning with the letter V. Unfortunately, we don't cover InfoSpace. We have hold recommendations on ValueClick and VeriSign. VCLK is a multifaceted provider of Internet advertising and marketing solutions. We think the company has executed quite well but see the shares as fully valued.

VeriSign has a variety of businesses centered on Internet and communications services. The company has invested aggressively in expanding its security and next-generation telecom infrastructure businesses with much acquisition activity over the past 12 months or so. Nonetheless, we see the stock as fully valued. We think that even though ValueClick and VeriSign are good companies, there are better places in the technology sector and the Internet segment to put new money.

Q: It's about time we asked for your strong buy recommendations, besides the couple you've mentioned.

A:

We're recommending 18 technology stocks as strong buys. We're emphasizing larger companies, as well as investments that aren't as reliant on cyclical drivers. Let's say our strategy can be described with two words: quality and secularity. Essentially, secularity means we're looking for companies whose businesses determine the growth and aren't necessarily reliant on a strong economy or tech spending for revenue and profit increases.

So, without further delay, our 18 strong buy recommendations include: Automatic Data Processing (ADP ), Canon (CAJ ), Cisco Systems (CSCO ), Citrix Systems (CTXS ), Cognos (COGN ), Dell, EMC, Fiserve (FISV ), Lam Research (LRCX ), Linear Technology, Maxim Integrated, McAfee (MFE ), Microsoft, Novellus Systems (NVLS ), Powerwave Technologies (PWAV ), Research in Motion (RIMM ), Shanda Interactive (SNDA ), and last but not least, WebEx Communications (WEBX ).

Another company I'd mention, our most recent upgrade to strong buy in our group -- yet characterized in a different sector -- is Audible (ADBL ), the world's leading purveyor of digitally delivered spoken-word audio. We upgraded the stock last week. It closed today around $18. Our 12-month target price on ADBL is $25.

Q: Curious about two "A" names -- Adobe (ADBE ) and Autodesk (ADSK )?

A:

Both stocks are ranked hold, notwithstanding their great execution as companies and appreciation as stocks. I personally cover Adobe. Following its announced pending acquisition of Macromedia (MACR ) on Apr. 18, the stock fell, and we responded with an upgrade to buy from hold. The shares appreciated some 18%, and we downgraded them on May 24. Basically, we like both Adobe and Autodesk as companies but believe the stocks are reasonably priced at this point.

Q: How would you describe your outlook for tech stocks for the rest of the year -- guardedly optimistic?

A:

I think that's a fair characterization. We're finding good fundamental stories with attractive valuations without much of a problem, but we aren't ragingly bullish right now, in light of concerns about economic strength, technology spending, and seasonality. So, as I indicated before, we're recommending that people stick to a strategy embodied by quality and secular growth.

Edited by Jack Dierdorff

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