Riding Tech Stocks To Greater Heights

Expect growth in chips, but beware: This bull market can buck you

It was bound to happen. A two-year rally that more than doubled the value of technology stocks finally ended with a sharp about-face early this year. The sell-off was triggered on Jan. 22 by worries about a slowdown at networking companies. From the Jan. 22 peak to the trough on Apr. 25, tech stocks dropped 14.4%, as measured by the Pacific Exchange Tech Index. Networking stocks plummeted 34%.

But the powerful boom in high-tech stocks seems far from over. They've come roaring back since their April low. Even potentially disastrous news on May 30 about sharply lower second-quarter profits at Intel Corp. wasn't enough to spoil a powerful May rally that pushed tech stocks to new highs for the year. Through June 2, the Pacific Exchange Tech Index was up 16.3%, slightly outpacing the Standard & Poor's 500-stock index, which was up 14.5%. Networking stocks, which are heavily owned by momentum investors looking for rapid growth, skyrocketed 39% through June 2.

Many tech gurus are bullish on the second half. Two concerns are the perennial summer sell-off and a potential price war in the personal-computer industry. Yet Intel's bombshell failed to change analysts' generally rosy outlook. The reason: Most tech companies are still making big profits. Industry earnings are expected to be up 30% in the second half, according to analyst estimates compiled by First Call. "We've had a major bear market with absolutely no change in industry fundamentals," says Garrett R. Van Wagoner, a small-cap specialist who manages three mutual funds under his name. "There are unbelievable values out there," he says.

"DIRT CHEAP." In the second half, the most closely watched segment of the high-tech industry will be small-cap tech stocks, where analysts are eagerly anticipating a rebound following the most severe correction in years. From May 21, 1996, to Apr. 25, 1997, the Hambrecht & Quist Growth Index, which tracks 275 small tech stocks, dropped 42%, while the S&P 500 rose 12%. Alberto W. Vilar, head of Amerindo Investment Advisors Inc., says that was the worst fall-off in small tech stocks since the crash of 1987. As a result, "small-cap tech stocks are dirt cheap compared to stocks in the S&P 500." He predicts the H&Q Growth Index will double in the next three to five quarters, outperforming the market.

Many tech-stock gurus are hedging their bets, buying both small and large tech issues. They're focusing on narrow sectors. One current favorite: specialty semiconductors. Communications- equipment companies are close behind. Their least favorite sector is personal computers, where some analysts are worried about low margins and stiff competition.

The two top technology mutual funds in the first half both made their money in chip stocks and are maintaining the strategy going into the second half. James K. Renck, manager of Merrill Lynch's Technology Fund--up 24.5% through June 2--has fully 60% of his fund's $650 million in assets in a small group of semiconductor stocks. Among his top holdings are Micron Technology and National Semiconductor, both up sharply in the first half.

Fidelity's Kaplan, whose fund was up 17% through June 2, recently held Texas Instruments, ASM Lithography Holdings, and Altera as his three top picks as of Mar. 31. Kaplan won't disclose whether he still owns the stocks, but he says semiconductor stocks remain his favorites, even after Intel's bad news.

Another self-described "chiphead" is Kevin Landis, co-manager of the Interactive Investments Technology Value Fund, last year's top technology fund. His favorite semiconductor stocks include Level One Communications Inc. and Sierra Semiconductor Corp., which both make communications chips that are used to maintain the Internet. Landis also likes networking stocks. His top picks are Cisco Systems and Ascend. He owned them at the bottom--his fund was down 35% at one point--and he has held them through the rally. Ascend is 55 1/8, down from its peak of 78 in January. His fund was ahead 17.9% as of June 2.

Other investors are eyeing bargains in software stocks. Van Wagoner likes Technology Modeling Associates, which specializes in arcane software that simulates semiconductor designs before they are actually made. At a recent price of 12 3/4, the company trades at 17 times 1998 earnings. Van Wagoner says that's cheap considering that he expects profits to grow 40% next year. Michael J. Mufson, co-manager of Putnam's OTC & Emerging Growth Fund, likes software companies that stand to gain from the year 2000 glitch that's expected to disrupt millions of computers. One favorite is Compuware Corp., which at 48 trades at about 23 times Mufson's expected 1998 earnings.

WAR GAMES. Large-cap stocks remain a relatively safe haven, as some investors see it. "Critical mass and market-share domination are still important traits for technology companies in 1997," says John T. Wilson, who manages $4.5 billion for State Street Research & Management in Boston. He likes Compaq because, he says, "its innovative approach to selling PCs is putting pressure on IBM and Hewlett-Packard." He's not worried about a price war because "there's always been a price war in the PC market." Wilson also likes L.M. Ericsson and Motorola Inc., which stand to be winners in the shift from analog cellular telephones to digital phones.

Barry F. Bosak, Smith Barney Inc.'s top tech maven, is an IBM bull. He argues that Big Blue is a buy even though it recently hit its all-time high, because its price-earnings ratio is only 11.7 times his estimated 1998 profits. IBM closed on June 2 at 87 1/8, up 35% from its low on Apr. 4. And he thinks IBM's business will be goosed by a new mainframe computer due out this summer.

Despite his fondness for IBM, Bosak advises investors to avoid most high-profile tech stocks. "You're better off if you stay out of the limelight," he says. Well-known companies are more likely to be caught in a downdraft, says Bosak, and investors can almost be guaranteed that one will occur. "The choppiness is enough to make you seasick," Bosak says. Bosak likes EMC Corp. and Storage Technology Corp., which both make computer-memory devices.

High tech is still a great place to invest. But make sure you've got a strong stomach.