Tech Stocks: Still Looking For The Bottom
Garrett R. Van Wagoner manages $3 billion in technology mutual funds, and he's not thrilled. Through Dec. 8, his funds are down an average 5% for the year, and he's worried 2001 will bring more of the same. The Nasdaq is doing even worse--down 28.3% for the year and 42.2% off its Mar. 10 high. Meanwhile, the economy is slowing, and tech companies are cutting growth forecasts. "It's hard to dive in when you don't know where the bottom is," he says.
Calling the bottom is tricky because the outlook for tech profits, while improving later in 2001, looks terrible in the first half. Bad earnings could keep lowering stock prices. But shares typically head up before profits do--and might take flight sooner if the Federal Reserve starts to cut interest rates. So investors who wait might miss the turn. To escape this bind, a lot of tech pros are putting their money in tech sectors that look relatively strong, such as software, data storage, and personal digital assistants.
MUDDY OUTLOOK. The first-half outlook is grim. Profits of tech companies in the Standard & Poor's 500-stock index will grow just 8.5% in the first six months, down from 56% in the first half of 2000, according to First Call Corp.'s consensus of analyst estimates. Business looks particularly lousy for such sectors as personal-computer makers, dot-coms, chipmakers, and telecom-equipment suppliers. What's worse, earnings estimates themselves "are in a free fall," says Charles L. Hill, First Call's research director. Don't be surprised, he says, if a lot of estimates are revised downward through most of January.
The second half of 2001 should be better, provided the economy improves. For the year, tech profits are expected to be up 15%, well ahead of the 10.6% earnings growth anticipated for the S&P 500--but behind transportation (up 24%), health care, and capital goods (both up 16%). Even so, tech remains the favorite of many of the largest growth funds. "Technology still has the fastest-growing companies anywhere," says Paul E. Marrkand, co-manager of the $41 billion Putnam Voyager fund.
Patient investors may fare best in some of the most battered sectors. Telecom stocks, for instance, are suffering largely because they can't raise new debt on the markets. "[But] if the high-yield bond market frees up, it will be a catalyst" for telecom, says Marrkand. As for chip stocks, Dresdner RCM fund manager Walter Price thinks many are becoming buys as they reach 10-year lows.
Most seasoned tech investors aren't willing to gamble on chips and telecoms yet. Instead, some are focusing on such market leaders as Cisco (CSCO), Sun Microsystems (SUNW), Oracle (ORCL), and Microsoft (MSFT). "We're playing a more prudent, risk-adjusted game and tilting more toward the heavyweights," says David E. Sette-Ducati, manager of the MFS Technology Fund.
NOSEBLEED. The trouble is, top stocks still command big premiums, with price-earnings ratios well above 50 times their 2001 earnings estimates. But fund managers pay up because they expect these companies' sales or profits (or both) to top expectations. Many of them favor software, where profits margins are high and sales are holding up, and data-storage companies, such as EMC Corp. (EMC) and rival Network Appliance Corp. (NTAP)
Sette-Ducati likes EMC, reasoning that large companies' high demand for storage will keep EMC from stumbling next year. EMC's nosebleed market cap is higher than IBM's (IBM), despite having just 10% of IBM's sales. But EMC management expects sales to grow 30% to 40% next year, against maybe high-single-digit growth for IBM.
In software, Marrkand picks Siebel Systems Inc. (SEBL) and Veritas Software Corp. (VRTS), because he figures sales growth in the coming year could exceed 40%. And several tech pros like Microsoft. They're betting that more and more corporate customers will soon upgrade to Windows 2000, which has been slow to catch on. "There's spotty evidence it may take off in the spring, and if that happens it will be the biggest new-product cycle since Windows 95," says Dennis McKechnie, manager of the PIMCO Innovation fund. He also likes Compaq Computer Corp. (CPQ), believing it will be the biggest beneficiary of a Microsoft upgrade.
Wireless communications stocks have been a disaster because of concerns about slowing demand and excess inventories. Still, some funds favor cell-phone and PDA companies. McKechnie likes Nokia (NOK). The handset maker's recent deal with AT&T (T), he believes, will help it take market share from Motorola (MOT) and Ericsson (ERICY). And he likes Palm Inc. (PALM), whose handheld personal organizer is so popular that he thinks sales growth could accelerate beyond Palm's current 60% clip.
Also popular are Internet infrastructure plays. One of Van Wagoner's top picks is Juniper Networks (JNPR), which makes routers crucial for long-distance data networks. At a recent price of 148 a share, Juniper is trading at a heady 194 times earnings estimates. But analysts expect sales to justify the price tag by growing some 110% next year, to $1.3 billion. "The valuation is enormous, but the opportunity is also," Van Wagoner says.
The tech shakeout isn't over. "In the next six months, a lot of companies will blow up," Marrkand predicts. "At the same time, a lot of the bad news has already come out and been digested by the market." Sooner or later, of course, tech will find a bottom and trek north again. And if the Fed cooperates, that could come more quickly than many expect.