Figuring the Future of Tech Stocks
As a symbol of investors’ rejuvenated interest in technology stocks, not much beats the hot streak of IBM Corp. shares in recent weeks.
The long-ailing computer giant’s stock surged $1.875 on Friday to a 20-month high of $68.125, helped by upbeat comments from two well-known Wall Street analysts. Measured since the end of June, IBM’s share price is now up 16%.
Many IBM buyers are focusing specifically on the prospect of faster computer sales growth overseas, as the economies of Europe and Japan pick up speed. The summer rebound in tech shares generally, however, seems driven more by a realization that the vicious spring selloff in these stocks was overdone.
In dumping tech issues during May and June, investors were responding to fears that sales and earnings would be victimized by a slower U.S. economy (courtesy of the Federal Reserve Board). But in July, many or most tech companies’ second-quarter earnings reports put those fears to rest.
Just last week, electronics leader Hewlett-Packard and software producer Autodesk both reported results for their quarters ended July 31, and the numbers were so surprisingly strong that Hewlett’s stock immediately leaped 11% and Autodesk’s rocketed 17%.
The resurgence of tech shares overall this summer has already been powerful enough to lift a key tech-stock index back into positive territory for the year-to-date. The 200-stock tech index compiled by San Francisco brokerage Hambrecht & Quist, which dove 13% between the end of February and the end of June, now is up 3.6% for the year.
In contrast, the Standard & Poor’s 500 index of blue chip stocks is down 0.6% year-to-date.
Beating the S&P; so far this year is a continuation of an important trend for tech investors: Despite hair-raising volatility in the stocks, the H&Q; index has posted bigger price gains than the S&P; every year since 1990.
That contrasts vividly with the 1986-89 period, when the H&Q; badly lagged the S&P; in three of four years.
Yet tech stock bulls complain that Wall Street still treats the computer business as if the plug could be pulled at any minute, without appreciating how large, how global and diverse an industry it has become.
Although it’s certainly true that the tremendous speed of technology product cycles means there is high risk in owning any single tech stock, the greater risk may be in failing to own a piece of a diversified tech portfolio in the ‘90s.
Efficiency, after all, is what the world economy rewards most highly today, and efficiency is what technology promises.
Here, three tech-stock veterans explain their optimism about the industry and where they see the greatest potential for investors:
* Michael Murphy, editor, California Technology Stock Letter, Half Moon Bay, Calif. A bear on the stock market overall, Murphy is bullish on the tech sector for a simple reason, he says: “Valuations on technology-driven companies are no higher than ‘other’ companies, even though (tech companies’) real growth rates are three or more times as high.” That disparity “can’t last,” he says.
Murphy believes Wall Street is just beginning to realize the true value of tech companies’ franchises. Why now? In large part, he says, it’s because so many investors now are part of the tech revolution via personal computers.
Technology, Murphy says, “has been demystified” by its spread. So the old argument against investing in tech stocks--”Don’t buy what you don’t understand”--is no longer valid, he says. “People have not only lost their fear of the unknown in technology, they are actively embracing it.”
More important, the global growth potential in computers and related equipment, telecommunications, biotechnology and other tech sectors remains spectacular, Murphy says.
For example, whereas there are 150 million personal computers in the world, he estimates that there are 250 million people who have the skills and income to buy a computer today but haven’t yet done so.
The semiconductor industry alone, Murphy says, will invest $100 billion in new plants and equipment over the next five years to meet the world’s burgeoning demand for computer chips--now standard equipment even in the lowliest household appliances.
Yet Intel Corp.--the premier name in chips--is a mere $63 stock. At that price, Murphy notes, it sells for just 11 times this year’s estimated earnings per share. The S&P; 500 index, in contrast, is priced at 15 times estimated 1994 earnings.
The point, Murphy says, is that tech stock prices as a group don’t come close to discounting the industry’s future growth. That makes this a must-own business, he says.
Besides Intel, his “core” tech holdings include disk-drive giant Seagate Technology, work-station maker Sun Microsystems, and Vitesse Semiconductor.
* Roger McNamee, money manager, Integral Capital Partners, Menlo Park, Calif. Like Murphy, McNamee finds the still-depressed prices of many tech stocks quite at odds with the companies’ outlook.
The average computer company, McNamee says, does about half its business overseas. With the dollar weak (thus lowering prices of U.S. goods abroad) and Europe and Japan in recovery mode, the stage seems set for healthy growth in the near term, he says.
But McNamee is less sanguine than Murphy that the market will begin treating tech stocks with due respect anytime soon.
“The profile of the average tech investor is a manic-depressive,” McNamee says. The industry is bigger and more complex than ever before, but few money managers have time to dig deep into the fundamentals, he says. So when the market perceives a problem in any part of the business, the typical manager’s reaction is to bail.
McNamee figures that extreme volatility will remain a hallmark of tech stocks. The savvy investor must learn to use that to his or her advantage, buying the stocks when they periodically plunge, he says.
But not just any tech issues. McNamee focuses on the major product cycles in the business--the innovations that generate massive new sales and create their own momentum. “As an investor, that’s where I want to be,” he says.
Microsoft Corp.’s expected 1995 rollout of “Chicago,” the successor personal-computer software to the blockbuster Windows program, is perhaps the most exciting major product cycle on the horizon, McNamee says.
Microsoft itself is the obvious way to play that cycle, he says, but many other tech firms will also benefit as “Chicago” lures new computer buyers and encourages others to upgrade. McNamee likes Cirrus Logic, for example, as a chipmaker with strong franchises in computer graphics and multimedia.
Another major cycle underway, McNamee says, is the development of the infrastructure for wireless communications worldwide, and the shift in telecommunications from analog to digital. Motorola remains a key way to play this cycle, he says, along with Mobile Telecommunications Technologies, the leader in paging services.
Finally, McNamee sees opportunity in the suppliers of equipment for interactive TV systems and other new wired communications networks. Alantec, a hot new designer of a telecom switching hubs, is one idea.
* Paul Wick, manager, Seligman Communications & Information stock mutual fund, New York. As well as tech stocks have performed over the last few years, Wick’s fund has done even better: up 55% in 1991, 17% in ‘92, 36% in ’93 and 10% so far this year.
He still is extremely enthusiastic about two tech sectors in particular: semiconductors and makers of machinery used by semiconductor producers.
The rise of computer networking alone, Wick says, is fueling a heavy demand for chips that isn’t likely to be sated soon.
Among niche chip players, he likes Xilinx and Altera Corp., both of which make high-density programmable logic chips. The idea there, Wick says, is that computer makers and other end users of chips can buy blank, programmable chips from Xilinx and Altera instead of footing the bill for custom-designed chips.
Wick also sees great potential in three major producers of memory chips: Cypress Semiconductor, Alliance Semiconductor and Integrated Device Technology. As computers learn to do more and at ever-faster speeds, they naturally require more memory capacity, he notes.
As the chip makers themselves expand, meanwhile, manufacturers of equipment used in chip factories also are booming. Applied Materials is one of the best-known equipment makers, but Wick favors some lesser-known firms, including FSI International, which he says has picked up some large orders in recent weeks.
FSI is the kind of bargain Wick is most comfortable with: The firm should earn $1.35 a share next year, yet the stock’s price is $15.50, or about 11 times earnings.
Indeed, despite tech stocks’ gains in the ‘90s, Wick says he still finds plenty of reasonably priced issues. 3Com Corp., for example, is a low-cost computer networker “that seems to be taking market share in all areas,” he says. At 24 times 1994 operating earnings per share, the stock must look undervalued to 3Com management, because the firm has been buying back shares, Wick says.
Similarly, Parametric Technology, a leader in software used in mechanical design (Ford Motor is a big customer) “is the most profitable public software company in the world,” Wick says.
But thanks to the spring plunge in tech shares, the stock--now at $27.875--is priced at just 19 times estimated 1995 earnings, he says.
Tech Stocks: Winner for the ‘90s?
An index of 200 technology stocks tracked by brokerage Hambrecht & Quist was a poor performer for most of the late ‘80s. But since 1991, tech stocks’ price appreciation has beaten that of the blue chip Standard & Poor’s 500-stock index every year. Annual price changes:
H&Q; tech index: 3.6%
S&P; 500: -0.6%
Sources: Hambrecht & Quist; Standard & Poor’s
How Tech Stocks Stack Up
Some money managers maintain that leading tech stocks are priced too cheaply relative to their growth potential. Here are some major stocks, their estimated or actual fiscal 1994 operating earnings per share (EPS), price-to-earnings (P-E) ratios and estimated annualized EPS growth rates over the next five years.
1994 Fri. Est. ’94 5-yr. est. Company high-low close ’94 EPS P-E EPS growth Applied Materials 54 1/2-36 1/4 50 1/4 $2.45 21 28% Cirrus Logic 44 5/8-24 7/8 30 3/4 $2.00 15 20 Cypress Semi. 19 7/8-13 1/8 19 1/4 $1.20 16 30 Hewlett-Packard 93 5/8-71 7/8 87 7/8 $5.85 15 17 Intel Corp. 73 1/2-56 63 1/2 $5.90 11 15 Microsoft Corp. 56 3/8-39 54 7/8 $1.88A 29 25 Parametric Tech. 40 1/4-21 1/2 27 7/8 $1.12 25 31 Seagate Tech. 28 3/4-18 5/8 25 1/4 $2.83A 9 15 Sun Microsys. 31 3/8-18 1/4 25 1/2 $2.02A 13 11 3Com Corp. 63 3/4-40 1/4 60 $2.54 24 41
Source: Value Line Investment Survey
NA: not available
