Why tech is hurting
The Nasdaq is down in 2006 even though the broader market is still sitting on yearly gains. Here's why.
By Amanda Cantrell, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) - While the month of May has not been kind to tech stocks, analysts and investors who follow the sector say that the recent pullback has little to do with tech company fundamentals. And that could mean that now is a good time to buy industry leaders.

Portfolio managers say the sector's losses are due to fears of a possible economic slowdown, worries about inflation and stock prices that may have gotten ahead of themselves.


The Nasdaq was sitting on a 6 percent gain for the year at one point earlier this month but is now in the red for 2006. The tech-heavy index has fallen more than 7 percent since May 8.

"We're in negative territory for the year even though the Dow is up. It's kind of depressing," said Daniel Morgan, a portfolio manager at Synovus Investment Advisors. "Even when you get good news, it doesn't last, and that's what's frustrating."

To be sure, the tech sector is not the only one that has suffered lately. Although stocks were trading higher Tuesday, all the major market indices have been caught up in a broad sell-off over the past several days.

And tech has truly taken it on the chin. Up until last Friday, the Nasdaq was on an eight-session losing streak, its longest since September 1994. And a brewing storm over grant practices for some options issued before the passage of the Sarbanes-Oxley Act could cast a pall over the sector in the weeks to come.

Inflation, early warnings and backdating, oh my!

Tech's troubles began on May 8 when Dell (down $0.23 to $24.15, Research), the world's largest manufacturer of personal computers, issued an earnings and sales warning for the first quarter. A day later, Cisco Systems (Research). the leading maker of networking equipment, disappointed Wall Street by failing to lift its revenue forecast for its current quarter, which ends in July.

Concerns about slowing growth for these bellwethers couldn't come at a worse time since the market is already afraid of inflation and the possibility of higher interest rates hurting profits.

"People were expecting the Fed to be done with its [interest rate] tightening, but now inflation seems to be rearing its ugly head," said Sunil Reddy, a portfolio manager for Fifth Third Asset Management. "The Fed may have to increase rates further, and that's affecting stocks."

Investors have also once again had to grapple with the issue of stock options, a perennial thorn in the tech sector's side. The Securities and Exchange Commission and federal prosecutors recently issued subpoenas or requests for information against several tech companies, including Juniper Networks (Research) and KLA-Tencor (Research), regarding grant practices for some options issued before the passage of the Sarbanes-Oxley Act.

The SEC and prosecutors are investigating whether these companies "back-dated" stock options for some employees. Stock options give employees the right to buy shares later at the price of the stock on the date of the grant. The employee makes a profit if the shares rise from the grant price by exercising the option and selling the shares.

"Back-dating" means a company retroactively changed the date of a stock grant after it had been approved by the board's compensation committee to a more profitable date, resulting in a bigger windfall for employees holding the options. But it may also result in accounting and tax problems for the companies involved and could violate some securities laws, according to the Wall Street Journal.

"A few companies have been hurt, and my worry is it's more prevalent than people realize," said Reddy of the back-dating issue.

But Reddy said he feels that the future still looks promising for tech. With a couple of exceptions, corporate earnings for tech companies have been healthy, Reddy said. For example, even as Dell struggles, its top rival Hewlett-Packard (up $0.04 to $32.22, Research) has continued to report strong earnings increases that have surpassed Wall Street's expectations.

Mark Lanyon, equity analyst at Morningstar, agreed, saying that some of the sell-off can be attributed to profit taking.

"There is nothing fundamentally different about these companies; people are sitting on nice capital gains, and there's a lack of confidence in the market. It's not a big mental stretch to see people taking their chips off the table."

Given the "sell in May, go away" mentality of many investors, analysts and investors said they don't expect a dramatic improvement over the summer months.

Patience a virtue for tech investors

But experts say those with patience -- and a longer-term view -- can find good investments in the sector.

Hans Mosesmann, senior vice president and semiconductor analyst for Moors & Cabot, recommends that tech investors sit tight, as he thinks tech fundamentals are healthy overall.

"I don't see anything unusual," he said. "Pricing is stable, nothing is collapsing; it's really kind of benign. That sets us up for a decent second half for investors that are willing to wait out the summer months."

Andrew Seibert, senior portfolio manager for S & T Wealth Management, said he is fond of companies involved in the areas of security and virus protection for businesses and consumers, such as Symantec (down $0.22 to $15.87, Research), which he holds in the firm's portfolios.

Seasoned tech investors are also looking around for stocks that once had high price-to-earnings multiples but now trade at more reasonable valuations.

For example, Dell, Microsoft and Cisco are all trading in a range of about 17.5 to 19 times estimated earnings for the current fiscal year. Those valuations are at a slight premium to the S&P 500 but nowhere near their lofty bubble-era levels.

Some value managers have taken a shine to Microsoft at its current levels, and American Technology Research analyst Shaw Wu is among those who thinks Dell offers more potential upside than HP at its current levels. Wu does not own shares of Dell, and his firm does not have an investment banking relationship with the company.

Morgan of Synovus agreed that some of tech's bellwethers are still producing decent earnings and are starting to look attractive at their current valuations.


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