Stocking Up on Software Plays

There are a lot of positive trends in the tech industry, from semiconductor companies restarting their spending on new plants and equipment to ongoing miniaturization, social media, and videoconferencing. When I add up all of those factors, I conclude that there is a reasonably good upside for tech stocks between now and yearend.

The economics of the tech industry are stronger than many other sectors. Tech gets cheaper and cheaper, which expands the overall pie of people who can afford items. In developed and emerging markets there is a global trend toward greater spending on tech goods and services. People are spending less disposable income on apparel and food, and more on tech gadgets and services.

Many tech stocks are still quite reasonably priced, especially big-cap companies like Microsoft (MSFT), which is one of our top 10 holdings. A good chunk of the fund is in software, where big swaths of the industry are very modestly valued. Software is a more predictable, stable, defensive business. The companies generate tons of cash, usually with pretax profit margins between 20 and 50 percent.

Check Point Software Technologies, which we own, is one of the most profitable companies on the planet. Its pretax profit margin is 50 percent. Since it doesn't have to spend money on new factories, it frequently plows that money into acquisitions, stock repurchases, or dividends. Two other software stocks we own, Symantec (SYMC) and BMC Software, once you strip out excess cash from their market capitalization, trade at eight or nine times trailing 12-month cash flows. One risk for them is they garner 30 percent or more of revenues from Europe. With the euro losing value against the dollar, it is a modest hit to the earnings of both companies.

Our largest position is in Synopsys, the leading company in electronic design automation, which is the business of selling software used to design chips. It sells to virtually every semiconductor company in the world, including Cisco (CSCO) and Apple (AAPL) (which is one of the fund's top three holdings). Synopsys' products are crucial building blocks in the overall technology food chain. With the recovery in the chip industry, Synopsys will see an uptick in its business over the next year or two. At around 22 it's a bargain, with over $7 a share in cash, and 90 percent of its revenues are recurring, from three-year contracts.

We prefer companies that are delivering profits and cash flow now, as opposed to mañana stories like clean tech. Pretty much every hydrogen fuel cell company has been a disaster. Clean coal has been a flameout. We have been very careful with some of the recent alternative-energy initial public offerings. They capture peoples' imaginations. For whatever reasons, people ignore negative cash flow and the fact that there is tremendous uncertainty about the future of the clean tech industry.

The Stats: Paul Wick has managed the $3.7 billion Seligman Communications & Information Fund (SPCIX), since 1990. The fund's five-year annualized return of 10.6 percent ranks it in the top 6 percent of Morningstar's tech fund category, as of May 12.

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