Revenge of the Nerds
Apple and Google are, like, sooo cool and sooo expensive. Time for a second look at some unhip tech stocks that the In crowd won't touch today.
NEW YORK (MONEY Magazine) - Last year tech's cool kids had their moment in the sun. Google grew into a verb, and its stock price more than doubled. Apple morphed into the music company, and its shares did even better than Google's. Corning spiked nearly 70 percent by selling glass for humongous flat-panel TVs. And Motorola rang up a 30 percent gain with its sleek mobile phones.
But as anyone who owns a pair of Uggs can tell you, fashion is fleeting, and tech's chic set may be losing its luster. Apple (Research) and Google (Research) are off their highs, and while they could rebound, it's hard to fathom how they could return all that much if you buy in today.
"There has been a Google burnout, the same for Apple," says Ted Parrish, co-manager of the Henssler Equity fund. "They were priced for perfection."
That doesn't mean tech has no place in your portfolio. On the contrary. Technology is still the fastest-growing part of the economy, and many technology companies have profit margins that a non-tech CEO would kill for. You just don't want to be paying Neiman Marcus prices. Remember how that worked out in 2000?
Instead, follow the lead of investors like Parrish, who troll Wall Street's discount bins searching for quality companies that offer the chance for great long-term returns.
What are they buying now? One-time stars such as Dell and Microsoft that make and sell decidedly unfashionable wares like business software and computers. These once trendy, now nerdy stocks could pay off for three reasons.
Microsoft, Dell, Cisco and Intel trade at price-to-earnings ratios in the mid- to high teens, which is anywhere from half to an eighth of what they fetched back in 2000. (Some lesser-known, high-quality techs are even cheaper.)
And yet they're all expected to generate annual profit increases of at least 12 percent a year for the next few years. That's 50 percent faster growth than the S&P 500 is expected to deliver, at a P/E ratio that's only about 20 percent higher.
Hey, they're not that nerdy
Techs that sell primarily to business have caught on to the fact that consumer tech spending is hot and will stay that way.
Result: Microsoft has latched on to the video-game craze with its popular Xbox 360. Cisco is buying Scientific-Atlanta, a maker of cable boxes and digital video recorders. And Intel is making a big push to expand beyond its core PC and server markets with its Viiv chipset for high definition TVs, digital music players and other multimedia devices.
They want to be your friend
Tech companies have finally figured out that they need to do more to support their stock prices than just increase their earnings.
"One of the real risks with tech stocks is a company that doesn't recognize it's no longer a rapid-growth business," says John Snyder, whose John Hancock Sovereign Investors fund owns Dell and Cisco. "But many have recognized that and are being more share shareholder-friendly with their cash."
They've backed off big stock-option awards and initiated large share buybacks, which will boost earnings per share. And Microsoft, Intel, Hewlett-Packard and IBM, among others, now pay dividends of more than 1 percent.
All these big techs are priced right today, but the best buys, based on a mix of valuation, growth and new products, are Dell and Microsoft. Here's a look at them, and at three other ways to invest in a growing segment of the market before it becomes fashionable again.
The computer maker took a hit in 2005 as it became clear that it can't grow as fast as it once did. Analysts expect sales to increase 10 percent in 2006, down from the 15 percent clip that Dell (Research) has long delivered. But with sales expected to top $60 billion this year, a double-digit growth rate is nothing to sneeze at.
Dell's vaunted efficiency will result in earnings growing even faster -- by about 15 percent a year. Yet the stock trades for 18 times 2006 earnings estimates, a multiple low enough to attract the interest of one of the most-respected bargain-hunting mutual funds around, Longleaf Partners. Dell is the fund's top holding.
Well-publicized shortages aside, the Xbox 360 can only help Microsoft (Research). And the latest version of its Office software suite plus the long-awaited Windows Vista operating system (the successor to XP) should boost sales and earnings for several years.
"New product rollouts are a catalyst," says Electric City Value fund manager James Denney, who owns the stock.
With expected long-term earnings growth of 12 percent, a P/E of 19 and a 1.3 percent dividend yield, the stock is the perfect example of what Denney calls a tech "tweener." "It's not a traditional growth stock anymore but not traditional value yet," he says.
That means it could take Wall Street a while to catch on, but Denney says stellar numbers will eventually win over investors.
If you like your stocks cheap, this disk-drive maker is for you, says David Garrity, director of research with Investec U.S., a New York-based brokerage.
A mid-size company -- its stock market value is about $13 billion -- Seagate (Research) should benefit from the same consumer fascination with gadgets that has propelled Apple and Motorola because its drives are a crucial component in MP3 players and digital video recorders.
In addition, the company's pending acquisition of rival Maxtor should help give Seagate more pricing power. The stock trades at just 12 times earnings, about the same as its projected long-term growth rate.
"Shares of companies like Apple and Motorola may have gotten ahead of themselves," says Garrity. "But companies further down the supply chain are reasonably priced."
Mutual funds and ETFs
Investing in tech is risky: Google fell 12 percent in three days after a January earnings miss. So consider spreading your money around via a mutual fund such as T. Rowe Price Global Technology (Research). Manager Robert Gensler "has proven to be a really good stock picker, and he has a proven bench of analysts," says Morningstar's Karen Dolan.
The fund, which holds Microsoft, Dell and IBM, also owns riskier stocks including Google and Juniper Networks. It has returned an average of 25 percent over the past three years, and its expense ratio of 1.5 percent, while no bargain, is lower than what most tech sector funds charge.
You're not tapping a manager's stock-picking talent; instead, you're buying an investment that holds dozens of stocks in the sector. Sure, hedging your bets may seem less cool than making one large wager, but cool doesn't last. Smart never goes out of fashion.