NEW YORK (CNN/Money) -
Attention tech stock shoppers: Shares of many large tech companies are actually trading at reasonable valuations.
After last year's 50 percent surge in the Nasdaq, investors had good reason to be concerned that tech valuations were stretched.
But during the past few months, techs have cooled considerably because of a variety of fears, most notably escalating tensions in Iraq, rising oil prices and concerns about eventual interest rate hikes.
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As a result, shares of several high profile techs, including Hewlett-Packard (HPQ: Research, Estimates) and Applied Materials (AMAT: Research, Estimates), have P/E ratios, based on calendar 2005 earnings estimates, that are below that of the S&P 500.
Several others, such as Texas Instruments (TXN: Research, Estimates), Microsoft (MSFT: Research, Estimates) and Intel (INTC: Research, Estimates), trade at just slight premiums to the broader market and a discount to the Nasdaq.
"We have a blue-light special on tech stocks in aisle 5," said Todd Campbell, president of E.B. Capital Markets, an independent research firm catering to institutional clients. "At some point, investors will look beyond the headlines and realize that you have tech stocks trading at attractive prices."
Granted, the big rally in tech stocks last year was due largely to investors betting on the strong sales and earnings growth that many companies have now begun to report, thanks to an improving economy.
Even tech executives are finally starting to show some optimism after being cautious throughout much of last year.
Officials at Cisco, Dell and HP all hinted that demand is on the upswing in their latest quarterly conference calls and IBM CEO Samuel Palmisano gave bullish comments about tech spending Wednesday.
So investors worried that growth has already peaked, partly due to fears of rising interest rates, may have left some money on the table.
Pessimism is a bit excessive...
Tech stocks tend to trade at higher valuations than the overall market because of their growth potential. And many large techs still have higher valuations than the S&P 500.
* based on calendar 2005 EPS estimates as of 5/18/04 | Source: Thomson/Baseline |
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The average P/E ratio, based on 2005 earnings estimates, for the 83 techs in the S&P 500 is 24, compared to about 16 for the S&P 500 as a whole.
So the trick for investors is finding companies with below-average multiples as well as above-average earnings growth prospects.
John Rutledge, manager of the Evergreen Technology fund, said that Hewlett-Packard, which reported its third consecutive solid quarter on Tuesday, and Nokia (NOK: Research, Estimates) are among his favorites.
HP, prior to Wednesday's nearly 6 percent move in the stock, was trading at just 12 times calendar 2005 earnings estimates, despite an expected long-term growth rate of 10 percent. Rutledge thinks the sentiment was too negative on HP and that this is the case with Nokia as well.
* based on EPS estimates for calendar 2005 as of 5/18/04 | Source: Thomson/Baseline |
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Nokia, the cell phone market share leader, has had a rough year. It has lost some share to rivals Samsung and Motorola due to an inability to meet demand for higher-end phones. But at just 13 times 2005 estimates, Rutledge thinks that it's a relatively low risk bet.
Campbell said he's recommending IBM (IBM: Research, Estimates), TI and Applied Materials, which also reported a strong quarter Tuesday.
"These stocks will find their footing," Campbell said. "The market is trading on emotion and I have a feeling we will get a snap back rally and move up in large cap techs in short order."
...but some techs are not worthy of higher valuations
Still, investors need to be wary when bargain hunting. A low P/E ratio is not always a good sign. "If a company has a low P/E, it's often for a good reason, such as a spotty record of earnings," Rutledge said.
Kent Mergler, president of Northstar Capital Management, which runs the Fremont Large Cap Growth fund, said that even though some telecom equipment companies, for example, now look "cheap", it's because of accounting concerns, which should not be overlooked.
Nortel (NT: Research, Estimates), for example, is trading at just 13 times 2005 earnings estimates but it has had some major accounting problems, resulting in the dismissal of several of its top executives.
Nortel rival Lucent (LU: Research, Estimates), may also look attractive, with a P/E of less than 20. But on Monday, the company was fined $25 million by the Securities and Exchange Commission for accounting irregularities. "Nortel and Lucent are not out of trouble yet," said Mergler.
Mergler said tech investors should look at growth in addition to valuation, before making an investing decision. For this reason, he's willing to own companies like Dell (DELL: Research, Estimates) and Cisco (CSCO: Research, Estimates) even though both trade at about 23 times 2005 estimates. Both companies have estimated long-term earnings growth of 15 percent a year, which is higher than the projected growth rates of HP, IBM and Lucent.
"If we can find a company with accelerating growth potential and a decent valuation then we're happy," Mergler said.
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