(MONEY Magazine) – Personal-computer makers were hot stuff in the mid-1990s, when the need for Net drove record-breaking sales, and cheap component prices fattened margins. Ahhh, those golden years. Dell Computer's profits ballooned more than 80%--per year--while its stock rocketed nearly 5,800% between 1995 and '98. Shares of Gateway and Compaq quadrupled.

Times sure have changed. PCs are no longer the center of the tech universe; now it's the hand-held digital assistants, wireless pagers and Internet home "appliances" that attract attention. The research firm Dataquest predicts worldwide PC sales growth will slow 4% this year, as ultra-cheap computers feed the notion that the personal computer is a worthless commodity.

The fallout? Declining growth rates at the industry's top PC-makers--and, yes, declines in their stocks. Shares of Compaq, Dell, Gateway and IBM are well off their 52-week highs. "The PC business is past its prime," says Ned Brines, co-manager of Phoenix-Engemann Focus Growth Fund. Adds Mark Herskovitz, manager of Dreyfus Premier Technology Fund: "There are other parts of the technology world growing more rapidly."

Nevertheless, there's an argument to be made that this is a good time to buy PC stocks--if you're an investor who values great brand names at reasonable prices. "The market already has priced in that the PC industry is a terrible place to be, that everybody's going to give away PCs, that the best days are behind them," explains Michael Corcell, a technology analyst with fund company AIM Management Group. "When there's this much worry, there's usually a buying opportunity."

The PC business has experienced down cycles before, only to bounce back on the strength of powerful new software or other innovations. In addition, falling prices are spurring small-business sales. And, of course, the Internet continues to drive consumer PC purchases. In this environment, the top players (Compaq, Dell, IBM, Hewlett-Packard, Gateway and Apple) should continue adding market share.

Let's look at valuations first. Compared to other technology stocks, price/earnings ratios in the PC sector don't look half bad. IBM is trading at 25 times estimated 2000 earnings; Compaq, at 24. Even Apple, whose stock is up 550% since Steve Jobs began his turnaround in 1997, still has a rather nonfrightening 34 P/E. Dell commands a somewhat loftier 43 multiple.

But if you think these stocks still seem expensive relative to the S&P 500's multiple (23 these days), remember that P/Es don't tell the whole story. When you take earnings growth rates into account, personal-computer stocks shine compared to the S&P. Each of the major makers boasts PEG ratios (P/E divided by its rate of expected earnings growth) lower than the S&P's as a whole. Judged by this yardstick, the cheapest PC stocks are Compaq, Dell and Gateway.

Let's do the numbers.

We'll start with Compaq, the No. 1 PC seller in the world. Unfortunately, its personal-computer business isn't very profitable. (Its commercial PC unit lost $79 million on $3.1 billion in revenues for the fourth quarter.) Much of Compaq's problem boils down to the uncomfortable fact that, unlike Dell and Gateway, it markets through resellers, which adds costs and bureaucracy to the sales process. Chief executive officer Michael Capellas is moving aggressively to slash operating expenses--he recently laid off 7,000 people--and simplify distribution. We like much of Capellas' thinking, but he still has too much work to do before we can recommend the stock.

That brings us to Dell and Gateway, our top picks in PC stocks. Both companies are growing significantly faster than the market, and their direct-sales models keep costs low. Dell predicts annual revenue growth in the low 30% range and net margins of around 7%--a comedown from historical rates, but still pretty amazing for a $25 billion company. Gateway says it can grow faster than 25% a year through 2004.

Interestingly, the reason for these impressive growth predictions goes beyond the PC--or "beyond the box"--as Dell and Gateway diversify their revenue mix by investing in more profitable and faster-growing businesses, such as financing and consulting services. This makes them less dependent on the box itself for growth.

Gateway, for instance, ended 1999 with 12% of revenues and 20% of profits coming from non-PC businesses, and Gateway CFO John Todd says he expects non-PC earnings to hit 40% this year. "A customer three years ago spent $3,000 over three years, 90% of that on the PC," Todd says. "A customer today will spend $4,500, but only $1,500 of that on the PC and $3,000 beyond the box. Gateway is uniquely set up to take advantage of that."

Its aces in the hole include an e-commerce alliance with AOL (which plans to merge with MONEY's parent, Time Warner) and a recent deal with Sun Microsystems to help market Gateway's products to big businesses. The company's Gateway Country stores--it's the only PC maker to have stand-alone retail outlets--should be an advantage when it comes to selling the new Internet devices and accompanying services. A full 21% off its 52-week high, Gateway is a "table-pounding buy," says Salomon Smith Barney analyst Richard Gardner.

Over at Dell, chief financial officer Tom Meredith says beyond-the-box revenues are 16% of the total and rising fast, with services the biggest piece of the action. Dell also recently reached No. 2 in the U.S. in sales of network servers (behind Compaq), and Meredith says sales in that segment are growing more than 50%. Dell is using these strengths, plus its e-commerce expertise (its website sales total $40 million a day), to turn itself into the Internet infrastructure provider to fledgling dotcoms. "Everyone thinks this space is going to grow at least 25% over the next four years," Meredith says. "That's just huge."

Dell stock has been languishing for more than a year, but Microsoft's Windows 2000 and increased corporate technology spending should spark a rebound in the stock this year. "Dell is the easy buy," says Robertson Stephens analyst Daniel Niles. "A sure thing."

Sure--as long as you don't expect a 5,800% stock appreciation.

--LISA GIBBS