A Fresh Take on Tech
Why a veteran strategist sees value in names like Dell, Oracle, and Cisco--but not Google.
(FORTUNE Magazine) - Many investors have been shying away from tech stocks since the bubble burst in 2000. For example, five years ago 80% of the money in Fidelity's sector-specific mutual funds was in technology-related portfolios, according to Ned Davis Research. Today that figure is down to 32%. FORTUNE's Corey Hajim talked with Edward Jones's chief market strategist, Alan Skrainka, a self-described champion of the individual investor, about why you should be looking at tech again, where to focus, and what to expect.
Most investors are gun-shy when it comes to tech, but you think that's a mistake. Why?
The three keys to successful investing are the quality of investments you own, the diversification of the portfolio, and maintaining a long-term perspective. Everything has to be viewed in the context of those three things. So we're really talking about making sure that technology is represented in your portfolio, rather than jumping in with both feet. Today most investors think tech "isn't where the action is," because the stocks have performed so poorly. But we think after two years of 4% growth in the economy, and with businesses flush with cash, corporate spending on technology is going to be pretty healthy in 2006.
Have valuations in the sector improved?
Dramatically. You can really play tricks with these numbers, so let's look at it carefully. As I figure it, the 20-year median price-earnings ratio of the Nasdaq composite is 22--excluding companies with negative earnings. At its high, again excluding companies with negative earnings, the P/E exceeded 60. On Dec. 31, 2005, it was 14.3.
What's the best way to play the sector now?
Many, if not most, investors are better off participating through a broadly diversified large-cap growth mutual fund. Having a diversified growth fund that smooths out the peaks and valleys of performance allows you to emotionally stay with the investment longer.
What about investors who want to buy individual stocks?
The first rule is to stick with established leaders--companies that look as if they have sustainable growth prospects--and make sure you buy them at a smart price. Three examples would be Dell, Cisco, and Oracle. All are leaders in their segments and have track records of proven performance and strong balance sheets. And look at their P/Es! Dell at the peak was 82; today it is 21, based on 2005 earnings. The stock is down 44%, and earnings for the past five years are up 118%. Cisco's P/E at the peak was 174. Today it's 17--just drop off the four. Isn't that unbelievable? The stock's down 78%, and earnings over the five years are up are 126%. Oracle: The stock is down 73%, earnings up 122%. The P/E was 129; now it's 16.
Clearly Google doesn't fit that mold.
Do a gut check before you step into something like Google. Folks believe Google will grow 25% per year. If you think that it's reasonable for a stock's P/E to be 1½ times its growth rate, Google should be roughly half its current price. What if Google grows better than 25%? I've got an AllianceBernstein report that goes back to 1980. What percent of growth stocks do you think increased earnings 10% or more three years in a row? Thirteen percent. And about 75% had negative earnings growth or losses in at least one year of the three-year periods in the study. So you can see what the odds are. Technology can be a field of broken promises. You need to tread cautiously if you are going to buy into these stocks.