The S&P 500 information technology index rose 61% in 2009, so it's reasonable to ask if, in 2010, tech stocks have anywhere to go but down. Dig into the data, though, and you'll find reason for optimism. Prices are at about the same level they were in early 2008, and after recent boosts in earnings forecasts, the companies trade at about 14.8 times projected earnings, down from 16.9 two years ago.
Last year's tech juggernaut was packed with lower-quality stocks, particularly in semiconductors, that had been battered in the downturn, says Fidelity Select Technology manager Charlie Chai. This year he predicts the leaders will be higher-quality companies "that put up sustainable growth." That outlook assumes a continued economic recovery. If no large bumps in the road emerge, here's how pros think tech stocks will play out.
LEADING THE CHARGE
Tech companies depend on four types of buyers: consumers, businesses, the telecom industry, and governments—each of which has cut back on spending. Consumers remain constrained by job worries, telecom customers are spending less, and government budgets are a mess. That leaves corporations to lead the charge back into tech, says Richard Parower, manager of Seligman Global Technology. Hardware and software companies are most likely to benefit. "A lot of people have outdated equipment and software," says Zachary Shafran, portfolio manager of Waddell & Reed Advisors Science & Technology Fund. Chai sees signs of the pickup in hardware sales and says that a software recovery tends to lag.
Computer companies in the S&P 500 are about 17% undervalued, and software outfits sell at an average discount of about 14%, according to Bloomberg's consensus of analyst forecasts. Those same analysts predict shares of Dell (DELL) could rise 28% over the next 12 months and software company Compuware (CPWR) could see its stock rise 27%, to 10. Shafran particularly likes Microsoft (MSFT). "It used to be people bought their products because they had to," he says. "Now [Microsoft products] are actually getting good reviews." At 29, shares are about 22% below their 2007 peak.
Spending outside of the developed world will become even more crucial for tech companies. "China, Brazil, and India will drive the growth," says Parower. He says about a third of his fund is in foreign companies, with 5% in Check Point Software Technologies (CHKP), an Israeli company that gets more than half of sales from outside the Americas. He also likes Amdocs (DOX), a European company that makes software for customer-relationship management and billing and gets about 25% of sales outside Europe and the U.S.
And if the global recovery stagnates? Morningstar analyst Toan Tran says to stick with quality: Apple (AAPL), Hewlett-Packard (HPQ), IBM (IBM), and yes, Microsoft. "If the U.S. economy doesn't do well, none of these companies will go bankrupt because of it."