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Net Stocks: Still Worth Uploading

The surge that has lifted Internet and security outfits is far from over, says S&P's Scott Kessler, who likes ADP and Yahoo

Information-technology stocks deserve a significant spot in investor portfolios -- roughly 16% to 17%, according to Scott Kessler, Standard & Poor's director of equity research in that area. That's the percentage represented by info tech in the S&P 500 index, and the sector now carries a market-weight recommendation from S&P.

So far this year, through Dec. 3, Internet stocks in general have done better than the 7% increase scored by the S&P 500, Kessler reports. The S&P Internet Retail Index is up 80%, and the S&P Internet Software & Services Index up 65%. Among the stocks Kessler singles out are Yahoo! (YHOO ), eBay (EBAY ), and Google (GOOG ).

And in the broad info-tech area, he points to a number of strong buys, including Linear Technology (LLTC ) and Maxim Integrated Products (MXIM ) in semiconductors, Automatic Data Processing (ADP ), Canon (CAJ ), Computer Sciences (CSC ), Dell (DELL ), EMC Corp. (EMC ), Hitachi (HIT ), IBM Corp. (IBM ), Microsoft (MSFT ), Motorola (MOT ), Qualcomm (QCOM ), and Veritas (VRTS ).

These were some of the points Kessler made in an investing chat presented Dec. 7 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk.

(Scott Kessler is a Standard & Poor's Equity Research Services analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.")

Q: Scott, the broad market keeps bobbing and weaving. How have the Net stocks been doing?

A:

Well, through Friday, Dec. 3 (year-to-date), the S&P 500 was up 7%, the S&P 1500 was up 8%, the S&P Internet Retail Index was up 80%, and the S&P Internet Software & Services Index was up 65%. So it's pretty clear that at least some Internet stocks have done quite well this year, easily outperforming most primary benchmarks. I would also point out that these indexes have outperformed over the 1-week and 12-week periods ending Dec. 3 as well.

Q: What is the outlook for 2005, and when, if ever, is a good time to jump back into tech?

A:

We've had a market-weight recommendation on the sector since this summer...we essentially recommend that investors have roughly 16% to 17% of their stock-based investments in the information-technology sector. That, of course, is in keeping with the percentage of the S&P 500 that's accounted for by technology, based on market capitalization. So the bottom line...is that we've been recommending investor participation in technology for some time, and prior to our market-weight opinion, we actually recommended an overweight position in tech.

Q: What are some of the best performers among the stocks you track, Scott?

A:

Well, I'll start with the two most obvious names -- eBay and Yahoo. Both of those stocks have done quite well, and we have recommended them at points throughout the year, based on what we consider attractive fundamentals, coupled with appealing valuations. We downgraded the shares of eBay last week on valuation but continue to rank Yahoo a buy (4-STARS, in STARS, the S&P Stock Appreciation Ranking System).

Another obvious name to mention here is Google, which, as many participants in this chat know, priced its IPO at $85 and in November actually traded above $200 a share. We believe that Google is reasonably valued at current levels and have a 12-month target price on the shares of $190.

Q: India and the Pacific Rim are booming. How do you recommend we invest in those tech-heavy markets?

A:

That's a great and timely question. Although I personally don't cover any stocks with substantial Asian exposure, it's clear that all of the major Internet players have been quite active in Asia over the past 12 months or so. Obvious examples include acquisitions by Amazon.com (AMZN ) of Joyo, eBay acquired India's Bazee, IAC/InterActiveCorp (IACI ) acquired a minority stake in China's eLong, and Yahoo acquired 3721. From a direct investment perspective, our IT Consulting & Other Services analyst, Stephanie Crane, recommends as buys (4-STARS) the following Indian outsourcing companies: Infosys (INFY ), Satyam Computer Services (SAY ), and Wipro (WIT ).

Q: Opinion, please, on InfoSpace (INSP )?

A:

We don't cover InfoSpace. However, our recommendations in the Internet content and advertising areas include ValueClick (VCLK ), which is a strong buy, and Yahoo, which, as we discussed earlier, we rank as buy.

Q: How about chip stocks? Is Triquint Semiconductor (TQNT ) a buy?

A:

Our recommendation on Triquint is hold. We actually have two strong buy recommendations in semiconductors: Linear Technology and Maxim Integrated Products. Buy-rated stocks include International Rectifier (IRF ) and Microchip Technology (MCHP ). Our analyst who covers this area, Amrit Tewary, favors these companies, given their appealing diversification, quality, and valuations.

Q: And in the same area, is Intel (INTC ) a buy?

A:

At this time, Intel is a hold. Our 12-month target price on the stock is $28, based on relative analysis. Although Intel continues to spend more on R&D than any other company in its industry, it has recently lost market share to Advanced Micro Devices (AMD ). Given recent news related to the PC business, which is very important to Intel, we think growth in this area could be harder to come by. Although we still consider the stock a bellwether, we believe names like Linear and Maxim offer considerably more appeal.

Q: What's your opinion on Symantec (SYMC ) -- fully valued or more room for growth? Computer security has been hot!

A:

Our analyst who focuses on security software, Jonathan Rudy, has liked a number of names in this segment and continues to do so. We have a strong-buy recommendation on McAfee (MFE ) and buy recommendations on both Check Point Software (CHKP ) and Symantec. We also are positive on the systems-software subindustry, and our strong-buy recommendations there include not only McAfee, but also Microsoft (MSFT ) and Veritas (VRTS ).

Q: Storage recommendations? EMC, QLogic (QLGC ), or Xilinx (XLNX )?

A:

We cover all three of those stocks. Our favorite among them is EMC. Our storage analyst, Richard Stice, believes that EMC is the best pure-play data-storage company that we cover. We believe the company will continue to experience market-share gains in 2005. EMC also has almost $3 per share in cash. Our 12-month target price is $21. QLogic we currently rank hold. We actually downgraded QLogic to hold from buy in late November, based largely on valuation. Xilinx is a semiconductor company that we rank hold.

Q: Should one hold or add to positions in Siebel Systems (SEBL )?

A:

Our recommendation on Siebel Systems is hold. Although the stock recently traded at a discount to peers, on an enterprise value-to-sales basis, it has what we consider a strong balance sheet. We believe the shares are fully valued, reflecting, in part, our opinion of the company's somewhat inconsistent execution.

Q: How are tech valuations looking? You referred to several downgrades because of valuation.

A:

Good question. There's no question that tech stocks have appreciated significantly, both since intermediate lows hit in August and following the Presidential election. A number of stocks have been downgraded on valuations, following recent appreciation. In terms of tech valuations in general, the sector trades at a p-e/growth ratio of 1.5, which is only modestly above that of the S&P 500 and the S&P 1500. Historically, tech has traded at more substantial premiums.

Another interesting note is that large-cap, mid-cap, and small-cap valuations are largely in line, suggesting to us that there might be value in large-cap technology. And, in fact, our current list of strong buys in the sector bears this out. In fact, we have several strong buys with market caps that were recently above $10 billion, including Automatic Data Processing, Canon, Computer Sciences, EMC, Hitachi, IBM, Linear Technology, Maxim, Microsoft, Motorola, Qualcomm, and Veritas. Oh, and I almost forgot our most recent upgrade to strong buy, Dell.

Q: Should I buy Netflix (NFLX )?

A:

Netflix is ranked hold. Clearly, the shares are well off their 52-week high, owing to revelations offered by the company about anticipated great competition from the likes of Amazon.com. We believe the shares are fully valued.

Q: What do you think about Network Appliance (NTAP )?

A:

We currently have a sell (2-STAR) recommendation on Network Appliance. Our 12-month target price of $22 is notably below the stock's recent price, owing to what we consider concerns related to competition and earnings quality.

Q: Who will benefit from the ever-growing trend to broadband and wireless?

A:

I don't think there's any question that many companies will benefit. Looking at our list of strong buys, I would identify Motorola and Qualcomm as obvious beneficiaries from the growth in wireless. We believe McAfee is probably our best play on broadband, in that their software essentially safeguards PCs and networks. ValueClick should continue to garner revenues and profits as a result of more Internet users using broadband, as the company is a leading purveyor of online advertising solutions and services. The company not only has a notable presence here in the U.S., but also in Europe. Of the companies I cover, I also think Yahoo is a logical play on the growth in broadband.

Q: You've given us a number of strong buys -- any to add?

A:

I actually think I've listed every strong-buy recommendation that we currently have. However, let me mention the only sell recommendation within my personal coverage, Sabre Holdings (TSG ). Sabre is not a name that many know on its face, but the company provides solutions to the airline industry and also owns a GDS, which essentially provides the ability for online travel sites and travel agents to make travel arrangements -- and, lastly, owns the well-known online travel agency Travelocity. I think we all know that the airlines face significant long-term structural problems.

What many people don't know is that Sabre's GDS and Travelocity businesses are facing increasing competition from existing companies such as Cendant (CD ), which recently bought Orbitz and announced the proposed acquisition of ebookers (EBKR ). The company is scheduled to provide an update to analysts on Thursday, Dec. 9. So, it's possible that I will look either very dumb or very smart when this transcript is published, but my recommendation suggests that I believe the shares are fundamentally challenged and are overvalued at the recent $23 per share.

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