Chip Morris manages the largest technology-stock fund in the country, and lately he has the scars to show for it.
Although the tech-stock sector still is red hot, Morris’ $12.2-billion-asset T. Rowe Price Science & Technology fund is lagging many of its smaller tech-fund competitors.
That is in part a function of Morris’ rising concern about technology-stock prices relative to the companies’ growth prospects.
And Morris, 37, has seen many tech stocks boom, and bust, in his nine years at the helm of the T. Rowe Price fund.
We spoke with him recently by phone.
Question: A number of technology-fund managers have been predicting a major pullback in tech stocks. Yet in recent weeks, what we’ve seen is a pullback in almost everything but tech. What’s your take on the sector’s outlook?
Answer: There are a couple of things to keep in mind. If you look back at the historical declines and recoveries in the tech sector going all the way back to September 1983--and we’re using the Pacific Stock Exchange [technology index], the PSE, as the proxy because that’s the oldest one--there have been 13 declines of 15% or more from the then-peak to the ensuing trough.
The most significant recovery, during the Gulf War, lasted about 16 months, and we were up 107%. To give you an idea [of where we are now], the PSE, if we go back to the bottom in October 1998, was up 267% as of the end of December 1999. That’s more than double the most significant recovery we’ve had going back over the last 17 years.
Obviously, that’s one yellow flag--that we’ve had an off-the-chart move, just a stunning move off the bottom.
Then you look at where valuations are, to the extent that anybody is even calculating them anymore. You could give up about 30% on valuations. That is, if fundamentals didn’t change, [tech] stocks could go down by 30%, and they still would be at the high end of the historic norms.
Everyone like myself has a vested interest in saying things are great, just relax, the stocks will grow into these valuations. But you cannot honestly look yourself in the [mirror] and go, “There’s no problem here.” There is a problem here. It could manifest itself in two years, two months or two hours. It’s hard to say.
Q: But couldn’t those same arguments about price-to-earnings valuations and share-price gains have been made six, nine or 12 months ago? And look at how well tech stocks have done over the last six, nine and 12 months.
A: Valuations really didn’t start getting out of control until the second half of ’99. Now, they were always high, but you had some room.
The bigger statement is that most people aren’t even looking at valuations anymore. The right strategy with respect to technology-stock valuations [in 1999] was to take the batteries out of your calculator.
Q: It seems clear that we’re in a momentum-driven market, and smaller tech stocks, in particular, now have that momentum.
A: The market has indeed gotten much more momentum-driven. And the fact that that has worked so well for the last 18 months is sucking everyone else into playing that game.
Q: But where does that leave your fund? With assets of $12 billion plus, aren’t you at a competitive disadvantage in a market like this, compared with smaller funds whose performance can be boosted dramatically by a few hot stocks?
A: Oh, for sure. We historically were a small- and mid-cap fund, but the asset growth has really pushed us into the mid- to large-cap stock arena.
Right now, we’re trying to hold a less risky basket of stocks and have a little bit more cash on hand. And the way we’ve done that is not by selling, but we’ve just been dragging our feet putting the money to work that we’ve received.
Q: What does a “less risky” basket of stocks mean when it comes to tech?
A: What it means is that, for instance, in the software space, in Internet infrastructure, we can own Oracle or we can own a handful of smaller, much more richly valued [stocks]. If we didn’t own Oracle, we might own E.piphany, Vignette, Commerce One, Akamai. . . . But we don’t.
We own Oracle. We know that Oracle could fall on hard times if the industry slows down, but no one is going to come out and put them completely out of business. If anything, they’re going to put somebody else out of business.
In the semiconductor arena, instead of owning lots of PMC-Sierra or Applied Micro Circuits--which are fine companies by the way, and we’ve owned both of those in the past--or, say, ARM Holdings out of the [United Kingdom], all trading at 200 times calendar 2000 earnings, plus or minus, we’ll own things like Xilinx, Analog Devices and Maxim Integrated Products. They are plays basically on the same things: communications components. But we can play at one-third the [valuation] multiple.
Now, we don’t kid ourselves. If the environment turns down, we’re going to get halved in many of those names. But we probably won’t lose 80%.
Q: That’s not to say you wouldn’t like to own some of these smaller “dot-coms” some day, right?
A: We absolutely want them. There are lots of good companies out there. The Internet space is spawning some companies with some very good ideas and some very manageable business models.
We’ve got a guy here that sort of focuses on small-cap tech. And we’ve got a laundry list of stuff we want to buy. And we’ve bought some as we’ve been given the opportunity to do so.
But for the most part, we’re still in some cases 70% of the way away from being able to buy these things with a clear conscience that we’ll actually be able to make money.
Q: Are you serious? They’d have to drop that much before you’re willing to step in?
A: Yes. Let’s take a look at ARM.
ARM Holdings is a $200 stock with about 63 million shares outstanding. So you’ve got a market cap of about $13 billion.
Now, they’ll probably do $100 million [in sales] in ’99. Let’s give them the benefit of the doubt and say revenue will triple in 2000, which I think is light years ahead of where any forecasts are.
Let’s say that for some reason, Motorola, Nokia and Ericsson had all been planning on doubling their [wireless phone] output, but the industry is only growing 50%. So there’s a rollback of inventory in the middle of calendar year 2000. That is, Nokia, Ericsson and Motorola all call up the chip suppliers and say, “We’re still good for the year, but don’t ship us a whole lot in June. And September is going to be flat, and we’ll come back in December and take more product.”
In that case, ARM is not going to come close to $300 million [in sales]. Maybe it reaches $200 million. So let’s say they do $200 million.
On a $200-million run-rate level of revenue, what is the appropriate price-to-sales multiple for a company whose growth has visibly slowed? Is it 10 times sales? That would put [ARM’s market cap] at $2 billion. But it’s probably higher than that. How about 20 times sales? Now, that would be a pretty aggressive multiple for an [integrated chip] company whose revenues have slowed, but let’s give them the benefit of the doubt and say it’s 30 times sales, or $6 billion.
[At that multiple], you’re still down 50% from their current market cap.
And if you gave them a multiple of 15 times sales, which is probably where it would go, you’d be down 75%.
You only need one thing to happen: You just need some shock to the system that dampens demand growth just a smidge, because the guys buying ARM Holdings are all momentum players. As soon as the momentum is over, they’re not going to care where they sell this thing. As soon as the company stops beating [estimates], they want out at all costs. And it’s going to be brutal.
Q: So in your mind, there is an advantage in sticking with large, established and relatively low-valuation tech stocks rather than playing the momentum game. Your fund is lagging many momentum-driven tech funds today, but you think your strategy ultimately has an advantage over them?
A: It does in a correction. But we under-performed in the fourth quarter by like 13 or 15 percentage points.
We were about as aggressively positioned as possible for the first half of that quarter, and then we started getting a little bit more defensive as the quarter progressed, in terms of what we held.
January was just abysmal. It wasn’t because we didn’t own enough Microsoft, Dell, Intel, Compaq, MCI WorldCom or Vodafone AirTouch. It was because we just can’t get enough of Liberate Technologies, Inktomi, RealNetworks, [et al].
We’re not going to be the fastest horse in the race (a) given our asset size, but, (b) just given [our] mentality that at some point you’ve got to say enough is enough, and it’s better to husband your assets and protect your shareholders than to say that it’s their money, their decision.
Times staff writer Paul J. Lim can be reached at firstname.lastname@example.org.
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Beating the S&P;, but Trailing Many Peers
The T. Rowe Price Science & Technology fund, the biggest tech-stock fund of all, has trounced the Standard & Poor’s 500 index in recent years. But the fund’s size and manager Chip Morris’ growing caution about tech-stock valuations have kept its returns subdued relative to many smaller, more nimble and more aggressive tech funds. The T. Rowe Price fund’s returns compared with the S&P; 500 and the average tech-stock fund:
For more information on the fund, T. Rowe Price’s Web address is https://www.troweprice.com.
Sources: Lipper, Morningstar, T. Rowe Price