10 years after Internet boom, mistrusted tech sector wins new admirers

SAN FRANCISCO - John Chambers, chief executive of Cisco Systems Inc., is turning 60 this year. Apple Inc. head Steve Jobs is 54. Larry Ellison, CEO of Oracle Corp., is pushing 65.

The icons of Silicon Valley are older, grayer, and - if you believe analysts who follow the technology industry - wiser than they were a decade ago, when the Internet bubble inflated company share prices and corporate egos.

"It's different this time" was the retort back then to skepticism about tech stocks' lofty valuations and pie-in-the-sky earnings outlooks. Of course, it wasn't different at all. Earnings mattered. Price mattered.

Yet the landscape today is different for technology investors - certainly the sector has consolidated since 1999. Survivors of the dot-com bust - such as Cisco, Apple and Oracle - are bigger businesses, in better financial shape, with broader market share and global reach.

And after years in the investment wilderness, the technology sector's thorough housecleaning and rebuilding, coupled with increasingly conservative management, higher-than-expected earnings growth and predictable, strong cash flow, is winning converts.

"Tech is at a very different stage than it was," said Savita Subramanian, a Merrill Lynch investment strategist. "It's gotten more mature and not as volatile. What's surprising is that tech still has the highest projected long-term earnings growth. It's almost a no-brainer; you've got great growth potential and low volatility."

It's perhaps not coincidental then that Cisco, the leader in computer networking equipment, just joined the Dow Jones industrial average. Cisco becomes the fifth tech firm - along with IBM, Hewlett-Packard Co., Intel Corp. and Microsoft Corp. (the latter two added in 1999, ironically) - in the select group of 30 stocks.

"Technology is our favorite (U.S. market) sector," said Brian Belski, chief investment strategist at Oppenheimer Asset Management Inc. "It is the most pristine sector in terms of fundamentals."

Indeed, technology is the only sector other than utilities where the number of dividend-paying companies has increased since 2007, according to Standard & Poor's Inc.

"They're financially strong," added Ronald Canakaris, manager of Aston/Montag & Caldwell Growth Fund, about tech companies in general. His large-cap mutual fund counts Apple, Hewlett-Packard, Google and Juniper Networks Inc. among its top holdings.

Technology firms "have reacted so swiftly to the downturn in the economy by reining in expenses and keeping inventories in line," Canakaris said. "This is characteristic of any sector that experiences a bubble; they learn from it."
Technology's appeal is no secret.

The economically sensitive sector now commands the biggest slice of the benchmark Standard & Poor's 500 stock-index. Tech's 18.3 percent gain so far this year is second-best performing S&P sector next to materials stocks. A tech-industry proxy - exchange-traded fund Technology Select Sector SPDR - was up 18.4 percent this year through June 4. The average tech-oriented mutual fund has done even better, surging 27.9 percent since the start of the year, according to investment researcher Morningstar Inc.

Technology investors are encouraged by signs that the worst of the recession is over. Tech stands to benefit as both companies and consumers spend more on computer systems and networking gadgets, proponents say.

"I haven't always been bullish, but I'm positive on technology for some simple reasons," said Hugh Johnson, chairman of investment manager Johnson Illington Advisors. "First, in the early stages of a bull market, historically technology is one of the best-performing sectors. Second, the relative performance has been positive. When a sector starts to outperform the S&P 500, I overweight it."

Johnson is particularly upbeat on software firms, leading him to stakes in IBM and Oracle, plus Cisco on the hardware side. Belski's work also favors those three stocks, along with Hewlett-Packard, Google, security-software giant McAfee Inc. and data-storage provider EMC Corp.

In addition to above-average earnings prospects, a consolidated tech sector has fewer companies competing for revenue. The number of tech companies in the Russell 1000 Index is about half of what it was in 2000, according to Merrill Lynch.

Moreover, analysts point out that many of these firms are sitting on cash hoards, which can be used for acquisitions and to steer clear of unforgiving credit and equity markets when they need capital. And since tech companies book a large percentage of their sales overseas, they benefit from a weakening U.S. dollar.

"As investment territory, tech is much more fertile now than it was during the Internet bubble in terms of being able to get high-quality companies with sustainable business models and real profits that are not wildly priced," said Mark Salzinger, editor of The No-Load Fund Investor newsletter.

Salzinger said he's hard-pressed to find a tech-sector mutual fund he likes that doesn't levy a sales charge, so instead he recommends Seligman Communications & Information Fund, run by tech-investing veteran Paul Wick.

To avoid a stiff sales charge, Salzinger points investors to Vanguard Information Technology ETF, which tilts toward large-cap names but also includes many smaller technology stocks. The small-cap exposure is important, Salzinger said: "There will probably be a lot of acquisitions in tech, so it makes sense to invest in an ETF that has more exposure to small companies."

Maybe the biggest hurdle for investors nowadays is getting over the mistrust that many still hold for technology stocks, which burned shareholders in the 2000-2002 bear market. And the growing bullishness for tech - coming when economic news worldwide is still grim - doesn't exactly inspire loyalty.

As a way to overcome misgivings, focus on larger, established companies with clear competitive advantages, said Toan Tran, associate director of equity research at Morningstar.

"Stay with the large-cap names," Tran said. "Technology is subject to quick changes; it's still a sector that attracts hot money, in and out."

Oppenheimer's Belski agreed. "We are large-cap tech buyers," he said. "They have the largest cash balances, and diversified product lines and businesses. They'll be levered toward all parts of the recovery."

(c) 2009, MarketWatch.com Inc.

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