There are pockets of opportunity for the brave

Thinking about trying to pick up some bargain tech stocks because the Nasdaq has dropped 23% this year? Don't kid yourself. Most tech shares are still expensive, at 32 times Wall Street's estimated earnings over the next 12 months--and that assumes profits don't fall more than they already have. Plus, corporate tech spending--the lifeblood of the sector--is still in the tank going into the second half. "It's just patently obvious that there are not a lot of earnings to support these [stocks]," says Scott Black, who manages $1.6 billion at Delphi Management in Boston. "You've got to take a leap of faith to buy them."

That's not stopping investors from jumping in. Some money managers are playing it safe by owning only the healthiest of the tech elite, including Microsoft (MSFT ) and Dell Computer (DELL ). Others are buying companies that are finding ways to boost sales, such as chip foundry Taiwan Semiconductor Manufacturing (TSM ). Some value managers are scraping the dregs for bargains, taking a chance on such beaten-up companies as Advanced Micro Devices (AMD ) and 3Com (COMS ).

Kevin Rendino, who manages $13 billion in value funds for Merrill Lynch, compares today's tech malaise to the banking crisis of the late 1980s and early 1990s, when Citigroup (C ) traded at a split-adjusted price of less than $2 a share. He thinks AMD, under selling pressure because of a revenue shortfall, is such a bargain. At $9.60, AMD shares are down about 80% from their bull-market high and trade close to book value. Rendino bets the company's new 64-bit processor for PCs expected later this year or in early 2003 will allow it to grab some market share from arch-rival Intel (INTC ). "When it does, our price target for the stock is $20 a share," says Rendino.

Other parts of the semiconductor industry are starting to recover, and some experts think it's one of the best industries in which to invest. One such play is Taiwan Semiconductor, which makes chips for numerous consumer and industrial markets. The company has been gaining business as cost-conscious U.S. companies outsource their chip manufacturing to foreign suppliers, according to Gail Seneca, manager of Phoenix-Seneca Growth Fund. At a recent price of $14 on the Big Board, it sold at 38 times estimated 2002 profits. But Seneca says the multiple is only 18.5 based on her estimated profits in 2003, and her estimates "have only been going up."

Another play in chips is Peak International (PEAK ) in Fremont, Calif. This tiny company supplies Asian chipmakers with packaging equipment. Revenues plummeted in its fiscal year ended Mar. 31, to $45 million from $86 million, following the chip industry's swoon. But Delphi Management's Black, a veteran value investor, says its order rates are improving as business picks up at Asian chip companies. At $7.21 a share, it's one of only a handful of tech stocks so cheap that, like AMD, it trades at book value.

The networking sector has been among the hardest hit. But strong balance sheets are key, says Mark Donovan, co-chief of equity strategy at Boston Partners Asset Management. That's why he owns 3Com. Sales were down 50% over the past nine months, and the company has steep losses. But at a recent price of $4.85 a share, 3Com trades close to the $4 a share in net cash it has on the books. "We're less willing to go out on the risk curve on a company like [heavily indebted] Nortel Networks (NT ) when 3Com has the stronger balance sheet," Donovan says.

Throughout the tech downturn, consumers have continued to buy digital cameras and DVD players at a healthy clip, and sales are expected to remain robust. That's why Christopher Ely, a manager of small-cap stocks at Loomis Sayles, likes Zoran, which makes chips for those products. Sales climbed 59% in the first quarter, to $31 million, and Wall Street forecasts a 138% earnings jump for this year. Ely believes Zoran's valuation of 32 times estimated 2002 profits is reasonable since he expects earnings to rise 50% more next year.

Following the hot consumer-technology products, Ely is also investing in gamemaker Electronic Arts (ERTS ). He expects the company to see a surge in video-game sales extended into 2003, fueled in part by recent price cuts in video-game consoles. At a recent price of $62.31 a share, Electronic Arts traded at 35 times Wall Street's estimated profits of $1.73 a share for the fiscal year ending next March. But Ely thinks profits could grow 30% next year.

Many investors aren't willing to make such long-range forecasts the basis of their tech bets. Instead, they're watching for a pickup in corporate tech spending. "I don't think earnings prospects for technology are well enough defined to sustain a rally now, but in a few months, that could change," says Jim Floyd, a senior analyst at Leuthold Group, a Minneapolis stock market researcher. In the meantime, investors should reject the notion that tech stocks will ever again perform as they did in the 1990s.

By Geoffrey Smith

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