HIGH TECH IS WIRED FOR REWARDSNew products and the Internet are likely to keep these jumpy stocks moving skyward
It took guts to buy technology stocks in 1996. Even the fastest-growing companies risked merciless pummeling at the slightest whiff of bad news. Yet investors who braved the volatile industry were richly rewarded as high-tech stocks continued their journey skyward. The bellwether Pacific Stock Exchange Tech Index is up 22% through Dec. 13, handily beating the Standard & Poor's 500-stock index and continuing a boom that has persisted for more than two years. Since tech stocks took off in June, 1994, the PSE Tech Index has risen a blistering 129%.
Will tech stocks finally deflate in 1997? Not likely, say some of the top high-tech mavens. These companies remain the focal point of a world economy rapidly adjusting to technological change and are big beneficiaries of corporate and consumer spending. High-tech profits rose 25% this year and will grow an estimated 26% in '97--faster than any other industry, says John W. Ballen, a small- and mid-cap fund manager at Massachusetts Financial Services Co. in Boston. What's more, high-tech profits will rise at a time when overall corporate profit growth is expected to slow to around 10%, from 16% in 1996. ''People continually underestimate the value of innovations'' in the high-tech industry, says Kevin Landis, co-manager of this year's top-performing stock fund, the Interactive Investments Technology Value Fund, up 65% through Dec. 13.
Analysts point to numerous reasons why high tech will rule again in 1997. For one thing, the general environment will be conducive to growth: The economy is vibrant, interest rates are low, and inflation is tepid. For another, the industry is heading into major new product cycles. Intel Corp.'s Pentium Pro processor is due out next year and should drive PC and software sales higher. Services to support customers setting up complex networks and preparing to update systems for the year 2000 will also be in demand. Finally, the building of the Internet continues, and new generations of cellular telephones, modems, and other devices will become available.
While the outlook is bright for the high-tech industry, the question remains whether some tech stocks are fully valued or even overpriced. Keep in mind that stock values are based on future results, and valuations that appear ridiculously high may be reasonable if a company's profits are expected to keep pace. For instance, Premisys Communications Inc., which develops means for separating computer from voice data on copper wire, will see its business soar if it can persuade telephone companies to buy its products. At a recent price of $50 a share, it's trading at a hefty 55 times expected 1997 profits. But Scott W. Schoelzel, manager of Janus Olympus Fund, thinks the price is reasonable, since Premisys' profits stand a good chance of doubling next year.
DIFFERENT ROUTES. Still, investors need to tread cautiously. ''Anything with a p-e over 40 is vulnerable to disappointment,'' says Ballen. Indeed, the higher the price-earnings multiple, the more likely it is that the stock could be crushed at the first sign of bad news, even if profits remain strong.
There's more than one route through the technology minefield, provided you understand the companies you're investing in. Consider the different paths taken by the top two tech funds this year. Interactive Investments owned mainly semiconductor stocks, while runner-up PBGH Technology & Communications Fund focused on networking and tech-services companies.
Even if you don't know a packet switch from a light switch, you can still find smart ways to play high tech. Many investors like the prospects for the largest companies. Schoelzel is bullish on Microsoft, Compaq Computer, and Cisco Systems, all leaders in their industries. ''The strong are getting stronger,'' he says. Several analysts recently upgraded Intel's stock after management made upbeat predictions about demand for its semiconductors and higher profit margins. On Dec. 11, Merrill Lynch's Thomas Kurlak raised his 1997 earnings estimate on Intel to $9 a share, from $7.70, and said the stock could rise from the $130 to $140 range to $200 within the year.
Schoelzel's top pick is his fund's largest holding, IBM. The easy money in IBM has been made, after its recent run to a high of $166 a share. But Schoelzel thinks it will go still higher. IBM has refreshed its product line and has a dominant position in technology consulting. At $150 a share, IBM is trading at only 12 times 1997 earnings. Schoelzel argues that if profits grow 8% to 10% next year, as he expects, IBM should justify a multiple closer to 15, which would shoot the stock up near $200 a share.
Ronald E. Elija, manager of the Robertson, Stephens Information Age Fund, up 31.7% this year, favors most large PC makers and networking companies. Compaq, Dell Computer, and Gateway 2000 will all benefit as Corporate America upgrades to Intel's Pentium Pro processor and Microsoft's Office '97 and NT software. In networking, he likes Ascend Communications, 3Com, and Cabletron Systems--all big players in the growth of the Internet.
SWEET SOFTWARE. Some tech investors think the momentum of large-cap stocks may slow in 1997, and smaller issues may come into favor. Networking companies appear at the top of many investors' lists, and there's no shortage of names. David Pearl, co-manager of the Landmark Small Cap Equity Fund, up 36.6% through Dec. 16, says one of his top picks is Uniphase Corp., which makes technology that lets cable companies upgrade to 500 channels. At a recent price of $50 a share, it's trading at 50 times 1997 profits. But Pearl says it's a buy nonetheless, because profits should double next year. Another Pearl favorite is Network General Corp., a maker of network diagnostic tools. Pearl thinks the company could be a buyout candidate as larger rivals expand their focus on network servicing.
Another hot area is software, where companies often have high profit margins. John S. Force, manager of the PBGH tech fund, likes Parametric Technology Corp., which makes computer-aided design software and is taking business away from bigger companies, while sustaining profit margins in the 40% range. Force also likes Inso Corp., an outfit that makes spell-checking and related software for text publishing and has a key customer in Microsoft.
The high-tech industry is filled with fast-growing niche companies, and that's where many investors think the big opportunities lie. Roland Gillis, co-manager of Putnam's Voyager Fund, favors EMC Corp., which has 50% of the market for large data-storage systems. Gillis says a price war is ending in EMC's market and 1997 profits should grow 50%. He also likes Shiva Corp., which makes switches for local-area networks. The stock has fallen sharply in recent months, but Gillis says that's unwarranted since profits should jump to $1.20 a share next year, from 70 cents in 1996.
A KILLING IN 3-D. Landis' favorites are the most volatile tech stocks of all: chip companies. He likes Level One Communications Inc., which hopes to benefit from the Internet's growth with technology that expands the capacity of telephone wire. He also picks Avant!, which specializes in technology for submicron chip design, and specialty chipmakers, including Altera, Lattice Semiconductor, and Xilinx.
His only play closely tied to the personal-computer industry is S3 Inc., the leading maker of graphics chips for PCs. S3 stands to make a killing in the growth of 3-D computing next year--if Intel doesn't steal its thunder with a new graphics chip of its own. Landis warns that ''S3's leadership may only last six months.''
Sudden swings in company fortunes are the hallmark of the high-tech industry. Investors shouldn't be surprised to see wild gyrations in individual stocks or vicious corrections in the entire sector. But for the patient investor, high tech is the place to be.
By Geoffrey Smith in Boston
Updated June 13, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.