Tech: Blue-chip values

(Money Magazine) -- Big technology stocks have surged since August, outpacing the S&P 500 by an impressive margin. That may have you wondering whether the sector has gotten way ahead of itself and is due for a pullback.

After all, economists expect slow growth for the rest of the year, and tech shares can't roar ahead if businesses and consumers aren't spending.

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Several leading companies, including Intel, have already announced disappointing results for the fourth quarter and modest outlooks for the coming year.

But to my thinking, many tech stocks in the Sivy 70 still look attractive if you're able to hold them for five to 10 years. The sector was hammered so badly six years ago that it remains substantially undervalued, even after recent gains.

Price/earnings ratios are still as much as 20 percent below historical levels. For that reason, you'll likely profit in the long run if you simply include an index of big tech stocks, such as the Technology iShares (IYW (Charts) exchange-traded fund, in your portfolio.

You can do a lot better, though, if you consider companies individually. Look for reasonable share prices combined with compelling strategies, and avoid the pricey shares of firms with serious current problems.

Seven of the Sivy 70 are pure tech businesses. Here's a rundown of their prospects.

Cisco (Charts), which I've recommended several times over the past year and a half, were up nearly 60 percent in 2006. But I think the stock is still undervalued because Cisco has a convincing strategy.

The company has long dominated the market for corporate networking equipment. Now CEO John Chambers is trying to boost sales to consumers, which account for less than 10 percent of total revenue.

Cisco has made three acquisitions in that area, including Scientific Atlanta, the leading maker of set-top boxes for cable TV. And Chambers expects to make another half-dozen consumer-oriented acquisitions, which should be easy to finance because Cisco has $19 billion in cash and investments on hand.

Microsoft (Charts) may not rule software forever, but it's still the market leader. Upgrades of Microsoft's operating system and business applications won raves at the Consumer Electronics Show in January.

The company's ties to computer makers are so strong that these software systems should remain dominant for at least another five years. And the Xbox game console could soon start adding significantly to earnings growth.

While not cheap, Microsoft's shares are fairly priced. And with more than $31 billion in cash and short-term investments on hand, the company can acquire whatever it needs to stay competitive.

At IBM (Charts), business is continuing to improve. The company's mainframes, once thought to be on the way to obsolescence, are still competitive choices for massive jobs like university- or company wide records and administration.

Mainframes typically come with service contracts, and services account for half of IBM's revenue. In addition, the company is developing specialty chips, such as those used in video games. It also has the largest software business after Microsoft. And the shares are cheap.

Semiconductor sales are expected to rise a healthy 10 percent this year, according to the Semiconductor Industry Association. However, demand for different kinds of chips will vary a lot, and excess inventory has been building up at some companies.

Texas Instruments (Charts), a leading maker of specialized chips, has strong franchises. But one of the key uses for TI's digital signal processors is in mobile phones, and the latest popular phones use fewer chips. Even so, the stock has excellent long-term growth potential and is fairly priced.

With a potential chip glut, some forecasters think sales of semiconductor-manufacturing equipment will dip in 2007. Nonetheless, Applied Materials (Charts), the market leader, has great long-term growth prospects and looks very cheap.

The problem for Dell (Charts) is that PCs are increasingly a commodity business. Profit margins are getting squeezed, but Dell can't make up for that on volume because there isn't enough sales growth to be had. Plus, the stock is pricey.

Intel (Charts) is suffering from rising inventories. And although some new products are off to a promising start, net income plummeted 39 percent in the most recent quarter. Tough competition from rival Advanced Micro Devices has eroded Intel's profit margins. With an above-average P/E and mediocre growth outlook, Intel is no bargain.

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