NEW YORK (CNN/Money) – Following a more than two-year slide, the Nasdaq fell nearly 10 percent in July, and investors are still panicking about technology stocks. Will there be a rebound? Is there no hope?
But while it may look like a straight shot down, there has been at least one key change: Investors seem to finally be trying to differentiate between companies that face severe problems and those that may be struggling now but have a viable chance of surviving for the long-term.
"People are differentiating again -- it's not just a mass dumping," says Richard Williams, an analyst with Summit Analytic Partners, an independent equity research firm. "All of a sudden, company specific news matters."
Looking for winners
Technology as a whole may not be dead but the trick for long-term success is finding companies that have weathered the downturn and are in position to benefit most from an upturn. How does one go about doing that?
Wendell Perkins, manager of the JohnsonFamily Large Cap Value and JohnsonFamily Small Cap Value funds, says that he only buys technology companies with little or no debt and a relatively large amount of cash. He says that survivors in the tech sector will be companies with strong enough balance sheets to enable continued spending on research and development.
With this in mind, Perkins says one of his top holdings is Check Point Software Technologies, a developer of Internet security software. Check Point has no debt and $1.2 billion in cash. What's more, the stock is trading at just 15 times 2003 earnings estimates, with earnings expected to increase at a rate of 20 percent annually for the next three to five years.
| * As of most recent quarter, ** Based on estimates for next fiscal year | | Sources: CNN/Money, FirstCall, Company reports |
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Williams also likes Check Point because of its healthy balance sheet and dominant market position. Check Point is the dominant player in the market for security software for virtual private networks (VPN). VPNs allow companies to set up a shared network over the Internet.
Other software companies with strong balance sheets and substantial market share that Williams likes are FreeMarkets, a leading maker of business-to- business software and Retek, which develops software for retailers. Although both companies recently reported disappointing quarters, Williams says the fact that they have very little debt and are cash flow positive is encouraging.
Some larger companies that Perkins considers tech survivors are Oracle, Microsoft and Apple. Oracle has about $5.8 billion in cash and just $300 million in debt. The stock has been a relatively stable performer during the market's recent turmoil; it is actually up slightly in July even though competitors SAP and Siebel Systems reported dismal second quarter earnings. SAP's shares have fallen 23 percent this month while Siebel's stock has plunged 35 percent.
Microsoft, of course, has possibly the best balance sheet of any company in the world, with $38.7 billion in cash and no debt. And although Apple has been struggling lately (it issued an earnings warning earlier this month), Perkins thinks that the stock is worth a look because it is the only innovative company in the personal computer sector. Apple spent about 7.5 percent of its revenue in the last quarter on research and development, a higher percentage than Dell, Gateway, and Hewlett-Packard.
Don't ignore fundamentals
Of course, it's hard to focus on the merits of individual stocks when it seems like there's a new accounting disaster every day. But Arnold Berman, chief technology strategist for Soundview Technology Group, says that investors need to move beyond the bearish headlines.
"Investors have been so preoccupied by the market that they are not thinking about stocks," Berman says. "The issues people are worked up about today, whether or not there are lots of mutual fund redemptions or if options should be expensed for example, have nothing to do with business fundamentals."
And Berman thinks that fundamentals are slowly starting to turn for select areas of technology. He says he expects a classic tech recovery to unfold, namely that semiconductor companies and other firms tied to the personal computer industry will rebound before business software and communications. So the best opportunities for investors would be in stable companies in the chip and hardware sectors.
To that end, Berman likes Texas Instruments, United Microelectronics and Micron Technology in the chip sector. And on the hardware side, Berman has a contrarian pick in Hewlett-Packard. Berman concedes that there are integration risks for the stock -- H-P completed its merger with Compaq in May – but that the main reason the stock has fallen lately is due to concerns that Dell is going to enter the printer market. Berman says fears of Dell "eating Hewlett-Packard's lunch" in printers are overdone and that the stock looks like a bargain, at just 11 times earnings estimates for fiscal 2003 (which ends in October)
In addition to being cheap, H-P fits the other tech survivor criteria as well. The company has $8.9 billion in cash and $4.4 billion in long-term debt. So its balance sheet isn't really problematic. And even though it's difficult to predict just when economic conditions will make a turn for the better, the technology stocks with strong balance sheets should benefit along with the economy.
"Technology companies still have the power to grow faster than the economy," Perkins says. "Once we see the economy stabilize, which it will, and capital spending improve, which it will, earnings and cash flow will improve."
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