Technology's bargain bin
A lot of tech stocks have taken a beating in this difficult market. Here are three that will bounce back when the economy recovers.
(Fortune Magazine) -- If you thought Nortel looked cheap in mid-December at 27 cents a share, you were right. At that price, Canada's largest networking equipment and services company, with estimated 2008 sales of $10.5 billion, had a market value of $131 million.
The problem, of course, is that a month later Nortel declared bankruptcy, and its stock plummeted to about a dime before being suspended from the New York Stock Exchange. Pin a maple leaf to your wall to remind yourself that cheap does not necessarily mean a bargain, especially with volatile technology stocks in this economy.
In normal times tech investors look for earnings growth. But during a period like this, when profits are more likely to be falling than rising, tech investors are on the prowl for value. There are still a few tech stocks with lofty price/earnings ratios - Apple, Netflix, and Amazon, for example - but many former highfliers, including Microsoft, Intel, Motorola, and Cisco, are trading at multiples usually reserved for insurance companies and other unexciting fare. The question is, How can you find the cheap technology stocks that are most likely to rebound powerfully when this miserable recession ends?
One approach is to look at dividends. Andy Bischel, chief investment officer of SKBA Capital Management, based in San Francisco, believes dividends give an accurate reading of the board's real attitude toward the company's prospects. "Most mid- and large-cap companies don't set their dividend policies whimsically," Bischel says. "We believe dividends give you a good indication of the balance sheet and the ability of the company to sustain earnings."
Start there, and then drill down into the long-term prospects of an industry, Bischel says, and you can land on a company like Intel (INTC, Fortune 500). "I didn't think in my lifetime I would have the opportunity to buy Intel as a dividend play, but it's offering a 4% yield, better than Treasuries, after the stock was blitzed," he says. (Shares fell 30% in the past 12 months.)
With the PC market slowing along with the rest of the economy, there are clearly dark times still ahead. But Bischel believes there will be a huge appetite for Intel's chips when the recession ends. "Intel has plenty of new product in its pipeline," he says, "and we think there is greater and greater pent-up demand being created now."
Nokia (NOK) also boasts a dividend yield of 4% - and hidden growth potential. Nokia has had trouble regaining a foothold in the U.S. (see "Nokia's North America Problem"), but it remains the world's No. 1 handset maker, selling 468.4 million mobile phones in 2008 while keeping its 40% market share. "There is this weird bias in the U.S. equity markets toward high-end phones from Apple and even from Palm now," says Kevin Landis, who holds Nokia in his $400 million Firsthand Funds. "Nobody is really talking about the mid-market or the low end. In places like China and India, Nokia goes toe to toe with everyone and is winning."
With the stock down 62% in the past 12 months, the Finnish handset giant trades at less than ten times this year's estimated earnings and 18 times next year's. Nokia has a cash hoard of about $8.7 billion - enough to sustain its dividend and still pour plenty of money into R&D, which is crucial to staying competitive in this field.
Dividends aren't the only way to identify a cheap tech stock. Mike Lippert, portfolio manager for Baron iOpportunity fund, likes to focus on free discretionary cash flow, which he defines as cash flow from operations minus the capital expenditures required to keep the company at its current size. He believes this figure gives him a good snapshot of the company's earnings power. He compares his cash-flow figure with the company's stock price and its projected long-term growth rate to find undervalued shares.
One stock that looks cheap to Lippert by this measure is Equinix (EQIX). The company, based in Foster City, Calif., operates data centers that act as hubs for the Internet. Customers include companies like Google, IBM, Microsoft, and Sony, among thousands of others that distribute content and services over the Internet. As the largest player in the field, Equinix can handle more capacity and offer faster access speeds than smaller rivals. And Equinix management has said it expects its earnings to outstrip its capital expenditures, which means it will be able to add data centers without needing to go into the frozen credit markets. Lippert figures that Equinix trades at about nine times his 2009 estimate for free discretionary cash flow, when historically it has traded at about 15 times. "At this valuation," he says, "it's hard to pass up." 
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