"A Time to Pick and Choose Carefully"

With a tech turnaround still iffy, S&P's Jim Corridore explains why he has only one buy recommendation: Brocade Communications

Technology stocks are likely to stay volatile for quite some time -- moving up on any shred of good news, down on bad. So investors must choose carefully, warns Jim Corridore, industry analyst for Standard & Poor's Equity Research & Services.

Corridore covers stocks of data storage, contract manufacturing, computer peripherals, photo imaging, and some data-processing companies for S&P. He has more avoids and sells on his list than buys. In fact, right now there's only one buy, Brocade Communications, which he likes for, among other things, its strength in storage-area networking.

Asked if he could pick five stocks to buy now and hold, Corridore selects Brocade, along with EMC, Flextronics, Concord EFS, and Symbol Technologies. S&P thinks investors should have a presence in technology for the long term but should underweight the sector in their portfolios for now, he reports.

Corridore made these comments in a chat presented June 19 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from this chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Jim, what do you make of all this backing and filling by the market? Do you see a second-half upturn?


I expect the overall market to stay in a trading range over the next few weeks, since there have been no signs of economic improvement in the U.S. And tech demand, particularly in telecom and datacom, has not rebounded...So for the near term, I expect continued volatility -- with tech stocks up with each positive announcement and down with each negative announcement.

Q: What areas of tech does your coverage for S&P focus on?


My coverage focuses on several tech sectors, including data storage, contract manufacturing, computer peripherals, photo imaging, and some data processing. As you can see, I'm a big generalist in technology.

Q: What parts of that group are doing best -- and worst -- right now?


Most of these segments are seeing a broad-based decline, reflecting the overall tech and economic slowdown. So basically, I'm trying to pick and choose within each sector to find the stocks that I feel will do best when demand rebounds. However, the data-processing segment has been relatively immune to a slowdown in this environment, since this sector helps other companies cut costs and improve efficiencies.

Q: Do you like storage stocks like EMC?


I do like EMC very much, although it isn't my favorite pick right now. My No. 1 pick right now is Brocade Communications (


). This company is the leader in storage networking infrastructure market which one of fastest growing areas.

~Q: When will tech stocks recover? A broad question we all want the answer to!


...I see no signs of a rebound until well after the summer is over, since the traditional summer weakness is combining with the economic slowdown to hurt demand. We're all hopeful that after the summer is over, we'll start to see signs of a pickup.

Q: You mentioned BRCD -- is that a buy for you [5-STARS in the S&P ranking system]? Any other buys?


Brocade is currently my only "buy" and is my favorite stock. With its market-share position, large cash hoard, and advantages in R&D and marketing, it should continue to pick up market share and should benefit more than any other company when demand starts to pick up.

I do have several stocks ranked 4-STARS ("accumulate") on the S&P ranking. They are: EFII (Electronics for Imaging), FLEX (Flextronics), EMC , EMLX (Emulex), SBL (Symbol Technologies), SRM (Sensormatic Electronics), CEFT (Concord EFS), and CVG (Convergys).

Q: Contract manufacturing was hot quite recently. What's going on there now?


The contract manufacturing industry is being severely affected by the overall technology downturn. These companies have seen large sequential declines in their revenues and are moving to cut capacity and reduce expenses. However, the future looks bright, as the current downturn should drive more demand for outsourcing.

Q: Any signs of new technology that looks promising -- something that might ignite demand and the market?


Within the data-storage segment, the new technology of networked data storage is starting to pick up traction, particularly in the storage area network (SAN) space. This segment allows companies to decrease their total cost of ownership for storage, while reducing the complexity and need to manage data...another reason why I like Brocade.

Q: In your own territory, do you have any stocks marked avoid or, worse yet, sell?


I do have a sell, which is a company called CheckFree CKFR . While I like this company, which is well-positioned in Internet billing and payment services, the stock is currently trading at what I see as a ridiculous valuation of 370 times my fiscal '02 earnings estimate.

I have avoids on Benchmark Electronics (BHE ) and SCI Systems (SCI ) in the contract manufacturing sector....In data storage, I have "avoids" on Quantum DLT & Storage (DSS ), McDATA (MCDTA ), Iomega (IOM ), and Komag (KMAG ).

Q: Your answer on CheckFree raises a good question: Why do valuations stay so high (though rarely that high) on companies with poor results?


Well, in CheckFree's case, the company isn't having poor results. It's doing well in its space, but I don't see the growth rate as high enough to justify that valuation. Other companies that aren't making money sometimes carry these lofty valuations due to a rapid revenue growth rate and expectations of an earnings turnaround.

Q: Do you think tech valuations are still far too high?


Certainly, the answer to that question depends on when demand starts to pick back up. What I'm seeing from my companies is that the current downturn isn't getting worse -- but isn't improving. So, should we go through another earnings season like the last one, with numerous preannouncements and downward revisions to guidance, there's room for further contractions in technology. But we're optimistic that once demand starts to pick back up, investors will resume their appetite for tech stocks.

Q: Does S&P continue to recommend that investors underweight technology in their portfolios?


We do still carry an underweight on technology. However, that largely reflects tech's large weighting relative to the S&P 500...we do feel strongly that investors should have a presence in technology for a well-rounded portfolio, because when demand returns, these stocks will start to take off.

Q: If you could buy five stocks and hold them for three to five years, which would you buy?


Well, my answer is going to be colored by my coverage areas. So, within my sectors, my answers would be: Brocade, EMC, Flextronics, Concord EFS, and Symbol Technologies.

Q: Of your five choices, BRCD is the only current "buy." Are the other four stocks you expect to benefit long term?


All the other four carry accumulate rankings.... Longer term, these stocks will benefit nicely from a recovery in IT spending.

Q: However, we should be pretty cautious with our investing right now?


Absolutely. That's reflected in the fact that I have more avoid and sell recommendations than buy ratings right now. This is a time to pick and choose carefully. The stocks that I like generally are leaders in their segment, have some type of competitive advantage over their peers, and even in the current downturn, are still growing somewhat.

Q: We all got unrealistic expectations in the big bubble. I guess it's time to come back to earth.


Well, I think we already have. And there's no reason why investors shouldn't continue to pay premiums for companies with strong growth rates, but obviously not at the levels we've seen in the past. Those days are over.

Q: Do you think the old tech leaders -- Cisco (CSCO ), Oracle (ORCL ), Microsoft (MSFT ) -- will be the leaders once the sector's down cycle ends?


I think that they will retain a presence as leaders in their segments, but there's always new blood coming along to push out the old-line companies. And I think that the growth in those sectors is generally maturing, and the Ciscos, Suns, and MSFTs of the world will have to come up with add-on offerings, new products, or new technologies to improve their growth rates. It will be some time, if ever, before Cisco is the market-cap leader again.

Q: In photo imaging, anything worth remembering right now?


The photo-imaging industry has been having a tough time of late, as it's one of the first areas that sees a delay in spending in an economic downturn. Having said that, the one company we do like in that space is Electronics for Imaging (EFII ), which we have ranked "accumulate." We see the company as well-positioned in the fastest-growing parts of that sector, which are high-speed digital color.... We recommend the stock for aggressive investors only.

Q: You also cover office equipment -- what's going on there?


My office-equipment companies are a potpourri of different technologies, so the results have been varied.... One company that stands out as doing very well in this environment is Symbol Technologies (SBL ). The company is a fast growing player in wireless and mobile computing.

Q: So any final words of wisdom, Jim? Buy Brocade?


Have you gotten the sense that I've pounded the table on Brocade a little bit? Kidding aside, in this environment, you have to go with the companies that are market-share leaders in segments where growth will be strong once the economy normalizes. For this reason, network storage, contract manufacturing, and data processing are sectors that I like.

Edited by Jack Dierdorff

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