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Investing in tech? A ready reckoner

February 16, 2008 11:58 IST

Bears might enjoy honey and salmon, but they're no fans of iPods and BlackBerrys.

A week ago, the Nasdaq Composite slipped the wrong way across a big psychological border into its first bear market since 2002. On Feb. 6, the tech-focused index closed at 2,278.75, bringing the Nasdaq down 20.37 per cent from its record close last October.

Given the official slide into a bear market, we spoke to a handful of big picture market analysts to see what they think of the sector right now. What we found was a wide divergence of opinion, on the challenges the sector now faces and how it will fare in 2008.

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One thing that everybody can agree on: Stock-market investors are now feeling very nervous about the tech sector, an abrupt change in attitude from 2007.

"Last year, tech had been a beneficiary of a flight to safety in some sense," says Richard Moroney, the editor of the Upside and Dow Theory Forecasts newsletters. "It was perceived as a group that could hold up because so much growth came from overseas. Now, there has been this steady downward pressure on the whole group. There isn't even differentiation between winners and losers. Investors are clearly concerned that the good times are over."

Still, despite the pessimism, tech continues to have its loyal defenders.

They point out that, as we're half way through the fourth-quarter tally, tech is holding its own. According to stimates, earnings at S&P 500 companies are expected to come in 20.4 per cent lighter than in the fourth quarter of 2006. Tech companies, however, are expected to post earnings growth of 28 per cent.

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Charles Schwab, for one, is telling investors to grab tech stocks right now. Brad Sorensen, director of sector analysis, currently rates the sector "overweight."

In a recent client note, Sorensen said he's been tempted to jump in with the crowd and sell, given the sector's rocky start to 2008. But he resisted the urge and now believes the sell-off could be the setup to a good buying opportunity.

Sorensen says he sees American companies, increasingly unable to compete on labour costs, using some of the cash on their balance sheets to boost spending in an effort to enhance efficiency and productivity. He also expects consolidation through mergers and acquisitions to increase, and he believes that new products will also spur demand. Finally, Sorensen says, tech still benefits from its exposure to all that global growth.

"The technology is well exposed to foreign sources of revenue, which we believe will help to support earnings growth as the US economy slows," he says.

One criticism of tech right now is that the sector is not immune from the problems plaguing the financial firms--some of their biggest customers.

"It's a matter of degree," says Moroney. "You need to be confidant that [sales to banks are] not the single growth driver for the company."

Moroney says that FactSet Research Systems, Jack Henry & Associates and Accenture are all examples of tech companies vulnerable to a downturn in tech spending in the financial sector. He adds, however, that he actually continues to like Accenture because the stock seems cheap and because it was performing well through the November quarter.

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But Paul McWilliams, editor of Next Inning Technology Research, looks to recent earnings results from Cisco as proof perhaps that struggling financials might not be as much of a drag on tech as some speculate.

"Cisco reported in its October quarter that finance and automotive and construction were both off," McWilliams says. "In this quarter, they reported that finance has come back around."

McWilliams adds, "Cisco is a great proxy. Finance companies did a lot of deck clearing in the fourth-quarter. We are in for more write-downs but not as serious as what we saw. The future looks better."

McWilliams is a Cisco and Intel bull.

"I am literally switching money from indexes to those companies," he says. "They are cheaper and have better growth prospects."

Another bearish swipe at tech is that consumers, unwinding in the aggregate from a massive debt and housing bubble, can't be counted on now to be massive buyers of expensive tech products.

"Increasingly, over the last five years, consumer electronics have played a greater role in the top-line growth of tech companies," says Doug Kass, general partner of hedge fund Seabreeze Partners. "The momentum of the last decade will be reversed. The tailwind in consumer electronics will be a headwind as the consumer is spent up."

Those gadget companies exposed to the consumer, like Apple, won't soon see those same dizzying stock prices, he says.

"They will not rally back to their old highs," Kass says.

McWilliams is no fan of Apple, either. He thinks it's over valued relative to short- term growth prospects. More broadly, he thinks tech companies that rake in the vast majority of their money from Western consumption will feel the pinch this year.

But McWilliams also cautions investors to keep in mind the bigger picture of just how robust the demand now really is from emerging markets, and how that historic surge in consumption across the pond will continue to benefit tech outfits long term.

"Half the people in this world now have cellphones," he says. "A good percentage of these people went from pre-Industrial Revolution to Information Revolution in 10 years. They need tech to compete, and they aren't going to stop investing."

Mark Mowrey, editor of the Prudent Speculator TechValue Report and analyst at Al Frank Asset management, cautions investors to stay diversified. He has 43 tech stocks in his portfolio.

"Software companies act differently than PC companies," says Mowrey. "Each space performs differently."

"Tech is a vast and growing industry that is supporting the worldwide economic expansion we're seeing," McWilliams says. "The people now saying to avoid tech don't know tech."

Joshua Lipton, Forbes