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Tech funds are different this time -- really
Real profits have lured investors back to the table, but it's not too late to get in. The signs say there's more to come.
By Timothy Middleton
It almost looks like the Internet bubble has re-formed -- but with a key difference.
Since last Octobers market lows, technology has reasserted the kind of leadership it showed in the 1990s. Since Oct. 9, the tech-heavy Nasdaq Composite ($COMPX) surged 24% through April 14, while the broader S&P 500 ($INX) advanced about 14%.
And nothing has been hotter than the Internet. For instance, online auction house eBay (EBAY, news, msgs) has seen its stock soar more than 70% since October, and other surviving Web stocks are also climbing to the skies. Its dot-com time again, says Don Cassidy, senior research analyst for fund consultant Lipper.
This time, though, it really is different. During the Internet boom of the 1990s, the hottest tech stocks didnt have any earnings.
Despite what you see in the papers every day, capital expenditures on technology have been positive for the last three quarters, and theyre accelerating, says Tim Woolston, market strategist with Boston Advisors. Corporate profits are beginning to revive, he says, and with that comes a greater willingness to spend on efficiency-improving products and services. Its all about improving efficiencies.
If you own tech funds, you can start looking at your statements again. If you dont, nows the time to reconsider. Technology has been manufacturing profits since Gutenbergs first Bible rolled off the press in 1454.
Back in the black
After three consecutive years of breath-taking losses, mutual funds that invest in high-tech stocks are finally delivering positive returns. As of April 14, the average tech fund was up 1.8% this year, trailing only the 2.8% advance of health-care funds among domestic equities.
Internet stocks are leading the rest because companies that survived the bursting of the investment bubble are poised to rack up dramatic gains in sales and earnings as economic weakness abates.
Take a look at the growth numbers that the surviving Internet companies are posting right now, says John Leo, co-manager of Northern Technology Fund (NTCHX). They really stand out relative to the average technology company, and certainly relative to the average industrial company in the marketplace today.
So technology funds leveraged to the Internet have done the best in the last six months.
| Can IPOs be far behind? | | Fund | Gain since 10/9/02 | | ProFunds Ultra Internet (INPIX) | 102.5% | | Jacob Internet (JAMFX) | 100.0 | | Amerindo Tech (ATCHX) | 77.4 | | RS Information Age (RSIFX) | 75.7 | | RS Internet Age (RIAFX) | 75.0 | | Streettracks Morgan Stanley Internet (MII) | 58.2 | | Fifth Third Technology A (FTTAX) | 57.0 |
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Note: Total return, Oct. 9, 2002 through April 14.
Source: Lipper
Mark Herskovitz, manager of Dreyfus Premier Technology Growth (DTGRX), says Web stocks are doing so well for two reasons. One, expectations of their complete collapse were not fulfilled, he says. And then, it looks like theyre going to actually be successful -- they are going to be growth companies.
One of the favorite stocks of many tech managers is eBay. It's a marketplace for buyers and sellers of just about anything, and the marketplace model is one of the most successful in capitalism.
The Big Board example
Think New York Stock Exchange, says Herskovitz. It has been the dominant exchange for a couple of hundred years. Now think of a company like that.
Marketplaces have extraordinarily high barriers to entry. It would take considerable effort and luck for a rival to surpass eBays entrenched position as the favorite place for buyers and sellers to meet.
If this sounds like a story straight out of 1999, it isnt, because eBay has a price-to-earnings multiple. Internet stocks in the '90s didn't, because they didnt have earnings.
But eBays P/E ratio is about 67 based on this year's Thomson First Call consensus earnings estimate, which daunts even some of techs true believers. Herskovitz, for example, has been taking profits in eBay.
We want to own it, but I wouldnt say wed be buying it in here, he says. We have been trimming eBay on this massive run-up.
But in the main, investors have been racking up profits in dot-coms, not taking them. Yahoo!'s (YHOO, news, msgs) P/E ratio based on this year's consensus estimate is about 71, while Amazon.com's (AMZN, news, msgs) is nearly 78.
As history has demonstrated as recently as 2000, and again in 2001 and 2002, multiples that high cannot long stand.
Finding techs intrinsic value
But even lowly manufacturers in the high-tech group are getting respect once again -- specifically, manufacturers of semiconductors and wafer-making equipment. Icon Information Technology Fund (ICTEX) has nearly 50% of its assets in this end of the market.
Icons strategy is to buy stocks that are relatively cheap to their intrinsic value, but have begun to enjoy accelerating prices. The market tells us what we like, says manager Craig Callahan.
Virtually all tech stocks are cheap now, he says, so its easy to find those offering good value, as well as signs the market is beginning to recognize it.
Icon is one of the rare tech funds, like Dreyfus, to have a positive five-year record. It ranks as fifth-best in the category over the five years ended March 31, and the Dreyfus fund ranks among the top 10 performers. The Northern fund finished in the top quarter of the group over that period, with a mildly negative total return.
The shorter-term winners are a more volatile group, laden with an extra dollop of risk. Fortunately for them, at least so far, the tech pop coincides with two events that have long histories -- wars and bear markets. Charles Schwab (SCH, news, msgs) has done research on both and finds the stars nicely aligned to support equity prices.
Why waiting can cost you
Bryan Olson, a Schwab researcher, says that since World War II, the market has always gone higher after major crises. In the year after the first Gulf War, it was up 9%, he says. After the Cuban missile crisis it was up 33%. After the assassination of JFK, it was up 20%.
And the end of bear markets has an even longer pedigree -- and a bigger bang for the buck. How things recover after a bear market is that they recover very quickly, Olson says.
One year later, prices are higher by 47% on average. If you wait one month in cash to get back in, your return is only 33%, he says. If you wait three months in cash, your return is only 18%.
I think the bear market ended in March, when Octobers lows were tested and not penetrated. So the recovery is six weeks old already. Risk, so severely punished in the bear market, is already being handsomely rewarded.
Im very bullish on the technology sector, says Jack Bowers, editor of the Fidelity Monitor newsletter, published in Rocklin, Calif. He has overweighted his model portfolios with tech-sector funds.
I think the fact the group was so washed out by the bear market, as well as the weakness of the dollar, which benefits their foreign sales, are two bullish factors, he says.
And Bowers (as well as Callahan) has something else going for him: Judging from the Nasdaqs surge, the market itself is climbing aboard this bandwagon.
What they're buying now
A consistent performer: The Icon fund has a big position in Cabot Microelectronics (CCMP, news, msgs), which makes chemicals used to polish wafers. Management has shown in a 10-year period that they hit their plans, says Callahan. We like to see consistency.
A perfect union: United Online (UNTD, news, msgs), representing the marriage of Juno and NetZero, offers low-priced Internet access. Shares are trading around $20, but Callahan values them at $30. Just when people throw in the towel on Internet stocks, theyre making money, he says.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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