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TECH STOCKS: WILD, WOOLLY--AND PROFITABLE IN '99?While volatile, they're likely to outrun the herd once again
For long-term players in particular, tech stocks are good to own because the sector, although volatile, tends to outpace the rest of the economy. And the last few years have made tech seem like a no-brainer. Since tech stocks bottomed in June, 1994, the PSE Tech Index is up 270%, vs. 158% for the S&P 500. The good news should continue in 1999. First Call Corp.'s consensus analyst estimate for growth in 1999 tech profits is 30%. Stock analysts' earnings estimates are notoriously optimistic and may well be too high, considering that the U.S. economy's growth is expected to slow down in the coming year. But the analysts are probably right that tech companies will do better than others. ''Tech stocks have the strongest outlook of any industry next year,'' says one such bull, John W. Ballen, chief investment officer at MFS Investment Management in Boston. Key parts of techland are firing on all cylinders. An explosion of electronic commerce is driving a powerful Internet and telecommunications boom. Gadgets such as digital cameras and 3Com Corp.'s Palm computers are flying off the shelves. And with the inventory glut of personal computers now past, PC prices are stabilizing. That is boosting profits of PC makers along with a broad swath of companies that rely on those companies' success, such as disk-drive makers. TWILIGHT ZONE. That's not to say, however, that all is well. Prices of many popular tech stocks, including IBM and Intel Corp., are at sky-high levels. A slowdown in the growth of capital spending could hurt the tech sector. Many experts expect a shakeout in pure Net plays such as eBay, Yahoo!, and Amazon.com because their valuations are in the twilight zone. Merrill Lynch & Co. analyst Thomas P. Kurlak says semiconductor stocks are overheated and warns investors to avoid all but a handful of niche chip stocks going into 1999. While the Year 2000 bug should produce strong consulting revenues, Credit Suisse First Boston software analyst Esther R. Schreiber thinks it will depress software sales. ''The panic button will go off'' in the second half of 1999 when companies stop buying software and focus on making sure their existing software works through the new millennium, she believes. As a result, Schreiber recommends only one stock--Microsoft Corp.--because she thinks it will sidestep the Y2K lull. Making the right choices is critical, because a rising tide does not lift all ships in the vast high-tech sea. Through Nov. 30, the top tech mutual fund was up 70.5%, while investors lost money in the worst performer, with a negative 17.4% return, according to Morningstar Inc. One reason: This past year, investors sidestepped many fast-growing tech companies just because they were small. But Ballen thinks that small-cap tech stocks may gain some ground on large-caps in 1999, given that the divergence in the valuations of large vs. small stocks is among the largest in history. The pros are focusing on companies that are likely to do well in a slowing economy or have a leadership role in a particular market. ''The trick now is to find companies that will succeed in their niche and that trade at reasonable valuations,'' says Paul Saperstone, technology analyst at State Street Research Investment Services Inc. in Boston. His top choice is Cadence Design Systems Inc., which helps industrial companies adapt chip technology to their products. Saperstone says Cadence's profits will grow about 25% annually over the next few years. At a recent price-earnings multiple of about 18 times estimated 1999 earnings, it's a steal, he says. DIZZYING P-E. Higher valuations aren't scaring away all investors, especially if the company is perceived as a market leader. One expensive stock many pros like is America Online Inc. At a mid-December price of $89 a share, AOL was selling at a dizzying 159 times expected earnings for the year ending in June, 1999. Paul T. Cook, co-manager of the Birmingham (Mich.)-based Munder NetNet fund, says the price is so high that ''nobody in their right mind would buy this stock unless they believed in the story.'' And he does believe it. ''They have a real opportunity to become a staple of the Internet, if they aren't already,'' he says. A similar leadership theme is used to justify investments in two expensive big-cap names by the co-managers of Dreyfus' Technology Growth fund. Mark Herskovitz and Richard D. Wallman like Cisco Systems Inc. and Lucent Technologies Inc. because they're the top players in their industries. Cisco is so dominant in networking that ''it's one of three or four tech stocks to buy and hold for a long time and ignore its valuation,'' says Wallman. Herskovitz says Lucent, benefiting from its role in building the Internet infrastructure, will prosper even if the economy slows, making the stock well worth its multiple of 45 times earnings for the year ending September, 1999. Kurlak favors another beneficiary of the PC industry rebound: Advanced Micro Devices Inc. Kurlak expects strong demand for AMD's Pentium-busting K6-2 chip to boost profits to $1.55 a share in 1999, from a loss this year. That would give the company a 1999 p-e multiple of 19. Other analysts expect earnings of only about 95 cents a share next year, making for a p-e multiple of about 30. TAKEOVER CANDIDATE. Ballen's favorites include top names in software and networking. He likes Oracle, Computer Associates International, Cisco, and Ascend Communications--long-rumored to be a candidate for takeover by Lucent. ''The world is going toward standardization, and these companies are all leaders'' worth buying even at current valuations, he says. All these tech companies trade at high p-e multiples compared with the broader market. But if you're looking for an easy way to tell if a tech stock is overvalued, good luck. Traditional measures such as price-to-earnings and price-to-sales ratios are sometimes taking a back seat to other concerns, such as a company's overall industry status. That means high prices and huge price swings will continue to be the norm. Still, if you want a good shot at outperforming the broader market--and are blessed with an iron stomach--high tech remains the place to be in 1999.
By Geoffrey Smith in Boston RELATED ITEMS
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Updated Dec. 17, 1998 by bwwebmaster
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