Tech: Almost Like Old Times

O.K., it's not 1999 -- but tech analysts are more bullish than they've been in years

The tech sector is starting to show signs of life. The NASDAQ is up 22% since Jan. 1, first-quarter earnings for the 80 technology companies in the Standard & Poor's 500-stock index rose 17% over the year-ago period, and many companies have raised earnings projections for the rest of the year. Is it time to get back into this wild but potentially rewarding sector?

Yes, if you do it carefully. It's a stock-picker's market, rather than all tech all the time. "I don't know anyone who expects we can turn the page and suddenly be in boom times again," says Kevin Landis, chief investment officer of Firsthand Funds, with $850 million under management. "But we're back on the path to growth."

Many tech analysts are more bullish than they've been in years. Tech earnings are forecast to grow 21% in the second half, according to Thomson First Call. That figure is down from 25% in January, but that's still normal trimming. "We're not seeing analysts slash numbers like they did a year ago," says Charles Hill, research director at Thomson First Call. "It's certainly a favorable development."

Another reason to get back into tech stocks: Prices are down from their nose-bleed levels. Tech stocks on average are trading at 29 times the next 12 months' estimated earnings. That's still higher than the average of 17 for the S&P 500. "Tech is down to historically normal but not historically cheap levels," says Thomas Smith, group head of information-technology research for S&P equity research.

Of course, tech is a vast sector. Where do you start? "Small-cap and mid-cap tech may be more attractive than large-cap," says Kevin Parke, chief investment officer at MFS Investment Management in Boston, with $112.6 billion in total assets under management. "The largest companies are going to have a harder time with revenue growth going forward." That's why he prefers companies like Network Associates, which makes antivirus software, and Avid Technology, which makes hardware and software that help media companies convert content to high-definition TV.


One strategy is to look for companies that will emerge to challenge the blue chips, the way Cisco Systems popped up behind IBM in the early '90s. In his sights: consumer electronics, especially the cell-phone market, which offers opportunity through expansion in India and China and with new functions, like cameras. For that reason, he likes OmniVision Technologies (OVTI ) of Sunnyvale, Calif., which sells a camera on a chip for cell phones. Within the next two years, 50% of about 500 million phones will include cameras, up from 10% of 400 million this year, estimates Landis. Omnivision uses a chip technology that packs more functions but gobbles less power, giving it an edge over Japanese rivals like Fuji Photo Film (FUJIY ) and Matsushita Electric Industrial (MC ).

Other pros look to past boom-and-bust cycles for clues. Semiconductors, the building blocks of everything digital, are typically the first stocks in and out of a recession. When tech spending picks up, demand for chips rises as demand for all sorts of devices picks up. Analysts now forecast third-quarter semiconductor earnings to rise 143% over 2002's third quarter and 205% over last year's fourth.

That's only the beginning. Even though the Philadelphia Stock Exchange semiconductor index is up nearly 50% since February, analysts expect demand for chips to rise next year and not hit a peak until sometime in 2005, leaving plenty of room for stocks to run. Kevin Rendino, managing director of the Merrill Lynch Basic Value Fund, has been buying LSI Logic (LSI ) and National Semiconductor (NSM ) In this market, says Rendino, "Any company whose prospects rely on economic recovery" is a value stock. His $6.4 billion fund now has 15% in tech, vs. nothing in early 2000. The last time tech weighed as heavily in Rendino's fund was 1998.

Another lesson from the past: As corporate spending picks up, tech buyers are likely to look at wares from innovators rather than the usual lines of PCs and servers. After the 1990 recession, everyone expected PCs to bounce back. Instead, networking and the Internet took off. Landis is betting on companies like Websense, which helps companies manage employee Internet usage, and Symantec (SYMC ), which sells Internet security software. Recent tech-spending sur- veys show security to be a high-priority purchase.

The software sector also offers opportunities. It typically sports gross margins of 85% and right now is an industrial consolidation play. PeopleSoft, the No. 2 player in enterprise software, recently bid for competitor J.D. Edwards, only to attract a hostile offer from Oracle, the largest database-software company, which is also in enterprise software. That's one reason why S. Irfan Ali, portfolio manager of the MFS Strategic Growth Fund, likes Oracle. "Buying a major competitor should help their market share and pricing," says Ali. "It makes strategic and financial sense and carries little risk." He's also a shareholder of data-storage software maker Veritas Software (VRTS ) which, like Oracle, "will benefit from an improvement in IT budgets." Tech stocks make up about 23% of this $1.4 billion fund, down from 39.5% three years ago.

Sure, growth-fund managers have always been drawn to tech. You know the sector is hot when numbers crunchers like Leuthold Weeden Capital Management start loading up. Analysts at the Eden Prairie (Minn.) firm rate 9 of 14 tech groups it covers "attractive," and it has been overweight in tech -- 32%, or nearly double the S&P 500 -- since the beginning of the year. Two years ago, tech was a 10% weighting. "Earnings momentum and recovery will benefit the tech group the strongest," says analyst Eric Bjorgen. If he's right, then this could be 1997 all over again -- at least for some tech stocks.

By Faith Keenan

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