Bulls See Reason for Hope in Tech
Few words on Wall Street have packed as much emotion as “Nasdaq” over the last five years.
Now, on the third anniversary of that market’s peak, the despair that followed the euphoria of the technology bubble era has given way to surprise and suspicion -- surprise at how resilient tech shares have been in recent months, and suspicion that it can’t possibly last.
But some money managers say it’s time to give many battered technology stocks the benefit of the doubt. Nobody’s talking about a return anytime soon to the record closing high of 5,048.62 on the Nasdaq composite index, set on March 10, 2000.
If the index just got back to 1,700, however, that would be a 30% advance from Friday’s close of 1,305.29 -- which would qualify as a heady gain in a stock market where expectations are severely depressed.
“The market is a game of choices. It’s a game of relative earnings growth. And tech is starting to grow faster than the rest of the economy again,” said Doug Foreman, chief of U.S. equities at Trust Co. of the West in Los Angeles.
He and other tech optimists believe that two years of cost-cutting by most companies in the sector should lead to significant profit gains if there is any sustained pickup in business capital spending. Tech bulls advise investors to look ahead, not behind.
While skeptics worry that tech stocks may still be too pricey compared with underlying earnings expectations, Wall Street historically has had a hard time suppressing its need to chase after companies that are growing at an above-average rate.
In other words, a bet on tech shares today may in part be a bet that many investors will again be willing to push the envelope with stock valuations -- though certainly not to the extremes of 1999 and 2000 -- if that’s what it takes to avoid being left behind in a market rally.
“Most growth fund managers are underinvested in tech,” Foreman said. “I think that means that when the stocks start to do better again, investors will have to increase their holdings.”
Of course, investors’ immediate concern is the U.S.-Iraq showdown. Major market indexes have dropped for six of the last eight weeks as war fears have mushroomed. The Nasdaq index lost 2.4% last week while the Dow Jones industrials sank 1.9% to end Friday at 7,740.03.
“We’ve seen gradual improvement in tech stocks, but it won’t continue unless there is a reasonable resolution to the Iraq crisis within the next couple of months,” said Larry Puglia, manager of the T. Rowe Price Blue Chip Growth stock fund in Baltimore. “If we don’t get clarification, that’s a problem for the whole market.”
Despite the war threat, the Nasdaq composite index, which comprises shares of 3,500 Nasdaq companies but is dominated by the tech giants for which that market is best known, has slipped just 2.3% year to date. That’s far less than the 7.2% decline in the Dow and the 5.8% drop in the Standard & Poor’s 500 index.
The Nasdaq 100 index of the market’s biggest names, including Microsoft Corp., Cisco Systems Inc. and Intel Corp., is among the few U.S. stock indexes that remain in positive territory in 2003, with a 0.3% gain.
The U.S. market overall hit five-year lows in early October, rallied sharply for about two months, and has since mostly edged lower as geopolitical concerns have taken center stage.
But since the start of the year some investors have been much more reluctant to sell tech issues than other stocks.
And some tech shares have continued to muscle their way higher this year. Internet portal Yahoo Inc. is up 20% since Jan. 1, to $19.62 on Friday. Fiber optics maker Corning Inc. is up 75% to $5.79.
Foreman argues that the speculative frenzy that marked Nasdaq’s peak three years ago has given way to a gloom that underestimates the long-term potential of companies including Yahoo and Net retailer Amazon.com.
These are “tremendous new growth companies, growing their cash flows at 100% a year,” Foreman said. On Wall Street, “you don’t get these kinds of opportunities” often, he added.
Nick Calamos, manager of the Calamos Growth stock fund in Naperville, Ill., is another money manager who has become increasingly bullish on tech. “Even if the sector is not at the very bottom, it’s time to start making those investments -- after all, you’re not going to call the exact low,” he said.
Investors shouldn’t fear that technology has entered a long-term decline just because of the magnitude of the stocks’ plunge from the peaks of the bubble era, Calamos said. “This is not a secular decline. It’s a cyclical downturn in the economy and the market,” he said.
In recent months Calamos has shifted his fund away from consumer-oriented companies and added stocks that can benefit from a pickup in business capital spending. For example, the fund has added computer networking giant Cisco, wireless technology company Qualcomm Inc. and anti-virus software maker Symantec Corp., he said.
Tech stock advocates say they aren’t simply wishing and praying that the sector’s fundamentals improve. A turnaround began for many companies in the second half of last year, and is sure to gain speed in the next few years because many tech users will have little choice but to upgrade their systems and devices, the bullish argument goes.
The federal government’s most recent report on 2002 economic growth showed that purchases of equipment and software -- considered a good proxy for tech spending in general -- rose at a 6.6% seasonally adjusted annualized rate in the fourth quarter, nearly matching the 6.7% rate of the third quarter and double the 3.3% rate of the second quarter.
That recovery in spending, though meager, helped to buoy many tech companies’ earnings in the second half of 2002.
Data tracker Thomson First Call in Boston said earnings of tech firms in the S&P; 500 index declined for five quarters through the first quarter of last year, were flat in the second quarter, then turned strongly positive in the third quarter, when the sector recorded a 29% jump in year-over-year profit.
For the fourth quarter, the preliminary estimate is that S&P; 500 tech companies showed a 23% year-over-year profit increase.
(Thomson First Call’s figures are for operating earnings, meaning results excluding one-time gains or losses.)
In the current quarter, with the economy slowed by war jitters, Wall Street analysts expect a 15% year-over-year earnings gain for the S&P; tech sector, Thomson First Call says. That is about twice what’s expected for the S&P; 500 companies overall.
Tech profit growth is expected to accelerate in the second quarter to about 25% year-over-year, compared with a 7% projected gain for the S&P; 500.
Some investors who still are leery of tech stocks say they don’t argue with the near-term earnings rebound expectations. For many, the concern is that business capital spending over the next few years may prove to be softer than expected, further squeezing tech suppliers.
Despite surprisingly strong sales for some tech firms in the second half of last year, “pricing and profit margins are weak,” said Ed Yardeni, investment strategist at Prudential Securities in New York. That raises the risks for tech if spending decelerates, he said.
Tech bulls concede they’re making one or both of two big bets: Capital spending will match or better expectations, and cost-cutting at tech companies has been, and will continue to be, severe enough to produce spectacular profit rebounds with even modest sales increases.
Roger McNamee, a principal at Silicon Valley investment firm Silver Lake Partners, said he believes that many tech companies’ costs are too high, including compensation. “But every quarter you’re going to see more companies with their cost structures in line,” he said, as expense reductions continue.
The result should be that “very small changes in the top line [sales] are going to produce huge changes in the bottom line,” McNamee said. “It is characteristic of Wall Street to underestimate leverage on the downside and on the upside.”
As for fears that capital spending on technology may remain in the dumps for years, McNamee conceded that it’s possible, but he noted that “technology is still the weapon of choice” for many companies in their drive to raise productivity and become more competitive.
If tech earnings are indeed far better than expected over the next few years, the stocks’ current price-to-earnings ratios will look more reasonable in retrospect, said Abel Garcia, a tech expert at AIM mutual funds in Houston.
Brian Eisenbarth, a “value”-oriented money manager at Davidson Investment Advisors in Great Falls, Mont., agrees with Garcia’s assessment, at least for certain tech stocks. He said he began buying Intel, Motorola Inc., Microsoft and Xerox Corp. early in 2002, and bought more at the start of the fourth quarter.
Eisenbarth has about 19% of his portfolio in tech stocks now. “I think the valuations you see now are reflective of a depression in tech,” he said. “But that’s not always going to be the case.”
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A look at some key tech shares
Here are 20 technology stocks and how they’ve fared since the bull market peak. Also shown are the stocks’ 2002 low prices, their recent prices, and the change from the low. The stocks’ price-to-earnings ratios are estimated based on analysts’ average estimates for fiscal 2003 and 2004 earnings per share.
*--* Ticker Bull mkt 2002 Fri Change Est P/E: Stock symbol peak low close from low ’03 ’04 Amazon AMZN $113.00 $9.03 $22.97 +154% 72 47 .com Yahoo YHOO 250.06 8.94 19.62 +119 66 47 BEA BEAS 89.50 4.59 9.64 +110 31 25 System s BMC BMC 86.62 10.85 18.20 +68 38 29 Softwa re EBay EBAY 127.50 48.85 79.90 +64 60 43 Symant SYMC 40.81 27.21 43.54 +60 25 23 ec Oracle ORCL 46.46 7.25 11.06 +53 27 24 Qualco QCOM 200.00 23.21 35.18 +52 25 23 mm Hewlet HPQ 77.75 10.75 15.80 +47 13 11 t Packar d IBM IBM 139.18 54.01 77.90 +44 18 16 Sun SUNW 64.65 2.34 3.18 +36 795 31 Micro Verizo VZ 69.50 26.01 34.06 +31 12 12 n Comm Intel INTC 75.81 12.95 16.01 +24 26 20 Texas TXN 99.78 13.10 16.30 +24 41 23 Instru m Nokia NOK 62.50 10.51 12.95 +23 15 13 Dell DELL 59.68 21.90 26.73 +22 27 23 Comput er Applie AMAT 57.50 10.26 11.96 +17 89 25 d Materi als Micros MSFT 59.97 20.71 23.56 +14 23 22 oft Motoro MOT 61.54 7.30 8.01 +10 22 15 la Cisco CSCO 82.00 12.24 13.24 +8 23 21 System s S&P; 500 1,527.46 776.76 828.89 +7 16 NA Nasdaq 5,048.62 1,114.11 1,305.29 +17 NA NA compos
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All share prices are adjusted for any stock splits.
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Sources: Bloomberg News, Thomson First Call
