That has led some Wall Street analysts to worry that the stocks in the sector could be overheated and poised to sink. But the outlook remains solid for makers of computers, software, and mobile devices. Earnings are growing, and the stocks of many companies appear to be priced at bargain levels. “Some of the stocks are the cheapest that they have been in years,” says Ian Warmerdam, portfolio manager of Henderson Global Technology Fund.
Prices of many technology stocks last hit a peak in 2000, Warmerdam says. At the time, consumers and investors were embracing all kinds of technology companies. Convinced technology products could work miracles, corporations bought more computers and software than they actually needed.
Investors raced to buy shares of technology powerhouses such as software giant Microsoft and Apple. Internet stocks with little or no earnings were also soaring. Then the bubble burst. Corporate customers cut their purchases, and dozens of Internet companies went out of businesses. During the three years ending in 2002, technology funds lost 74.6%, according to fund tracker Morningstar.
At the height of the bull market, technology stocks sold for 45 times their annual earnings. Then for much of the next decade, the multiple fluctuated between 15 and 20 times earnings. In the last several years, earnings have been increasing, but the share prices have rallied only sluggishly. The stocks currently sell for 12 times earnings. Investors have been reluctant to buy some of the stocks because they fear another technology downturn could be on the horizon.
Many of the biggest companies appear especially cheap. Consider Apple, which sells for a price-earnings multiple of 14—about the same as the figure for the average stock in the S&P 500. While Apple sells for an average price, the company is hardly an average business. Apple’s sales jumped 73% in the most recent quarter, a huge growth spurt for a large company. Sales of the company’s iPhones and iPad tablets are booming as customers around the globe race to grab the latest Apple products.
So why is the stock so cheap? Investors figure that Apple cannot possibly keep growing so fast, Warmerdam says. All too often consumer electronics companies have become hot and then faded quickly. Warmerdam concedes that Apple’s growth could slow down, but he argues that the stock is a good value because the company will continue growing. “Apple has extremely loyal customers who will continue using the products,” he says.
Besides reporting strong earnings, most technology companies also have rock-solid balance sheets. After so many Internet companies vanished a decade ago, the surviving technology companies resolved to hold plenty of cash so that they could stay in business during downturns.
Since then many blue-chip companies have been hoarding their cash. Now Apple has $30 billion in cash, while Microsoft holds $50 billion. The cash guarantees that the companies have the ability to stay afloat and invest in expansion.
Sales for many of the companies are growing nicely. Much of the new demand comes from China and other emerging markets. But there is also strong demand in the United States. During the financial crisis that began in 2007, many companies postponed making new purchases.
Now the average age of installed software is 5.5 years, and many products are becoming obsolete, says James Swanson, chief investment strategist for MFS Investment Management. Corporate customers have begun buying in recent months. “To remain competitive, corporate customers are beginning to play catch-up,” Swanson says.
To find bargains, consider stocks of companies that provide equipment for making computers, says Mark Oelschlager, portfolio manager of Red Oak Technology Fund. Sales of the equipment makers are highly cyclical, falling steeply when the economy slows and rising when a boom appears.
These days the companies are recovering from the slowdown and moving into a period of solid growth. Oelschlager likes Applied Materials, which makes equipment used to make semiconductors, vital components of many technology products.
The company has $6 billion in cash and only sells for 8 times earnings. “Demand for semiconductors is going to get greater and greater as the economy picks up,” Oelschlager says.
Growth should be particularly strong for search giant Google and other companies that benefit from online advertising. Google stands to continue expanding as more advertising moves from print publications to the Internet, says Kevin Landis, portfolio manager of Firsthand Technology Opportunities. “Most of the world’s advertising has not moved online yet,” Landis says.
Warmerdam likes Baidu, which is the Google of China. While most Americans have access to the Internet, only about one third of Chinese consumers currently have access. But China is racing to ensure that more of its citizens can get online. That is producing rapid sales gains for Baidu. The company accounts for more than 80% of all the searches done in China. In contrast, Google, handles about 65% of search traffic in the United States.
Warmerdam also likes Priceline.com, the online travel service. The company is expanding in Europe where online booking is still in its early stages of development. In the United States, half of all hotel rooms are booked online. But the figure for Europe is only 15%. “The online travel market in Europe could expand to the point where it matches the U.S.,” Warmerdam says.