Now might be time to check back into tech stocks
By John Waggoner, USA TODAYBack in 1999, money managers trumpeted technology stocks, arguing that soon there would be microchips in everything from credit cards to Toyota accelerators, and they were right. Unfortunately, they were also about 10 years too early. But today, tech companies are booming, despite a lousy economy and falling prices. It’s not a bad time to take another look at the tech sector, provided you have an exit plan in place.
Technology is a broad sector, and where you decide to invest in tech depends, to some extent, on your outlook for the economy as a whole. If you’re an optimist, and you feel that the world economy is going to grow more rapidly than expected, then you should consider investing in companies that make semiconductors — the brains of modern computers — or even in semiconductor equipment makers, which make the machines that make computer chips.
Semiconductor companies tend to be depressingly cyclical: They soar as the economy picks up, but eventually overproduce, leaving them with a pile of unwanted chips as the economy hits its downturn.
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So far this year, the cycle has been up: Many semiconductor companies, such as Intel (ticker: INTC), have seen record earnings as the economy has recovered from the worst of the recession. Driving the semis: Strong demand for consumer electronics, particularly smartphones. “A lot of these technology purchases, such as new computers and phones, have become necessities,” says Ryan Jacob, manager of the Jacob Internet fund.
Businesses, too, have started to replace their aging technologies with new machines. “There gets a point where you can only push off the upgrades for so long,” Jacob says. “They’re really necessary purchases at this point.”
Strong demand, even in a sluggish economy, augurs well for chipmakers. What Jacob finds particularly compelling about semiconductor companies now is that they are getting higher profit margins, even though chip prices continue to fall. Intel, for example, reported its best earnings ever this week, and said it expected a gross profit margin of 66% in 2010, well into the higher end of its long-term range.
Jacob’s favorite chipmaker is SanDisk (SNDK), which makes memory chips, particularly flash memory, the kind used in digital cameras.
The chip stocks have two potential problems. The first is that they tend to swoon once they hit peak margins. Jacob isn’t worried about that, as long as the companies continue to increase their production efficiency. He figures that as long as manufacturing efficiencies drive down costs faster than prices decrease, chipmakers will be able to increase profits.
Would a slowdown be a problem?
A bigger problem, however, would be an overall slowdown in demand, which is what worries Charlie Chai, manager of Fidelity Select Technology. He’s sold most of his economically sensitive stocks — such as chipmakers — because he’s worried about slowdowns not only in the U.S. but in Europe and China, too.
Even though chip inventories are lean, he figures a slowdown in the world economy will still spell harder times for chip manufacturers. So he’s trying to make his portfolio a bit more conservative by investing in larger, stronger companies with more predictable earnings. His top five holdings, as of the end of June, were such tech stalwarts as Apple (AAPL), Microsoft (MSFT), Google (GOOG), Cisco (CSCO) and Oracle (ORCL).
A reasonably defensive approach to tech stocks might be to consider relatively large, dividend-paying tech companies with low debt. Chip fans, for example, might consider Texas Instruments (TXN), which has no debt and a 2% dividend. The company sells for about 10 times its estimated 12 months earnings — relatively cheap.
Activision Blizzard (ATVI), which produces interactive software, also has no debt; it has a 1.35% dividend yield. Although the stock is somewhat more expensive, relative to expected earnings, it’s still fairly cheap for a tech stock and trades at 15 times its estimated earnings.
If owning just one tech stock scares you — and it should — then consider buying a technology fund. If you want a low-cost exchange traded fund, consider iShares Dow Jones U.S. Technology fund (IYW) or Vanguard Information Technology ETF (VGT).
If we’ve learned anything from technology stocks in the past decade, however, it’s that you have to leave them laughing. If you invest in an individual issue, or in a tech fund, set a limit to your losses. If your stock or fund falls 10% or more, sell it. You’ll probably get the chance to buy it back at a cheaper price — and you may sidestep a much larger loss. Two services, SmartStops (smartstops.net) and ExitPoint.com, will create moving sell points for individual stocks and ETFs for a fee and remind you when your stock is close to hitting them. In any event, don’t get into a tech stock without a plan for getting out. Being too late to sell a stock is worse than being too soon to buy it.
Tech fund top performers:
Top-performing technology funds the past five years: Total return1Fund, ticker20105 yrs.B2B Internet Holdrs Trust, BHH39.6%75%Firsthand Technology Opportunities Fund Investor, TEFQX6.0%60%Seligman Communications & Information Fund A, SLMCX-5.3%44%Internet Architecture Holdrs Trust, IAH-1.8%43%Fidelity Select IT Services Portfolio, FBSOX-4.7%42%Average technology fund-3.4%14%1 – dividends, gains reinvested through Wednesday Source: Lipper
John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. His book,Bailout: What the Rescue of Bear Stearns and the Credit Crisis Mean for Your Investments, is available through John Wiley & Sons. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com. Twitter: www.twitter.com/johnwaggoner.