Tech Stocks Are Ready to Click

TECH SHARES ARE on sale at giant markdowns. But as in the post-Internet bubble era, it's better to pick them up with a tweezer than a steam shovel.

"Technology is an expense to the economy, and it's an uphill battle for technology stocks to perform with such a negative economic outlook," says Bill Whyman, senior managing director at International Strategy and Investment and head of ISI's tech strategy research. Following Friday's precipitous drop the Morgan Stanley tech index is down 45% this year, compared to the Standard & Poor's 500's 40% decline.

Goldman Sachs' forecast for 2008 consumer spending is an anemic 0.6%, before it slips another 0.5% in 2009. And financial institutions, a key constituency for tech wares, are expected to cut spending on information technology by 4.5%, the first decline in a decade, say researchers at TowerGroup. Overall, real gross domestic product is forecast to grow just 0.3% this year and 0.1% in 2009. The cheap U.S. dollar, which aided overseas tech sales in the last couple of years, has started to strengthen against the euro and other currencies. That will pressure international sales as the financial slowdown goes global.

With the exception of the dot-com disaster in 2001-2002, global technology revenue growth has never fallen below 5% since the fourth quarter of 1995. But 2009 could be the year, Whyman warns; Wall Street's earnings estimates are still too high. "Tech is fighting economic gravity," Whyman says.

Walter Price, managing director of Allianz Global Investors and co-manager of the Allianz RCM Technology Fund, initially thought 2009 would be a recovery year, but now thinks it will be more like the 2001-'02 period that preceded 2003's turnaround. "I think people right now are really scared," since Lehman Brother's collapse, Price says. That fact was reinforced by Friday's collapse.

These are sound reasons not to buy willy-nilly in the tech sector — even though prices in many cases already reflect these worries. The trailing price-earnings ratio for tech of 16 hasn't been this low since 1995 and tech indexes are near early 2003 levels. Some huge stars with growing franchises, like Apple (AAPL) and Google (GOOG), have lost about half their market value in the last year.

And 2008-'09 isn't exactly 2001-'02. Thomas Laming, president and chief investment officer of TrendStar Advisors and portfolio manager of the AFBA Science & Technology Fund, notes that the tech market is no longer saturated with newly public companies with short track records.

Laming isn't expecting a terrible time. "I actually think tech will do well over the next few years," he says. Incumbents now have fewer start-ups challenging them.

Laming and a number of other tech specialists emphasize that it's best to look for well-run companies with strong balance sheets and outstanding technology to see them through several tough quarters. You'll find several candidates, like Hewlett-Packard (HPQ) and Qualcomm (QCOM), available at slashed prices.

But it's also a good time to search out lesser-known names whose stock prices have been dragged down with the tech sector, but their products hold promise. One example: Ceragon Networks (CRNT).

Most portfolio managers agree that big enterprise-technology concerns that sell to corporations, such as consultants, are likely to be safer near term than those relying on consumers. "Consumers are cutting expenses across the board," Whyman says.

Yet consumer-based companies like Wii maker Nintendo (NTDOY) and Amazon.com (AMZN) have their own value propositions. They offer consumers cheaper prices and, in Amazon's case, free shipping, an advantage in what may be a Scrooge-like holiday season.

Below we suggest opportunities that range from tech giants to Wi-Fi specialists to a medical technology provider and a clean-energy name that looks appealing.

Although some big-cap hardware is likely to get hit, Allianz's Price sees at least one exception: Hewlett-Packard. Price thinks that HP's printer-ink business provides recurring revenue flows at a time when overall spending is dwindling. Plus, the money manager likes its purchase of EDS, a consultant for businesses and governments on outsourcing. "I think it was a brilliant move," Price says, because services are more stable.

Price sees HP selling 10% more personal computers next year, thanks to EDS customers switching over from Dell and others.

Short-term, these hardware sales could "provide some incremental growth when others aren't buying servers and storage."

HP trades at eight times projected 2009 earnings. Price expects it to trade at 15 times, and thinks the stock can go as high as 60 from about 32 recently.

Dan Chung, chief executive of Fred Alger Management, contends that Cognizant (CTSH), a technology outsourcing outfit, is the best in its class, with the biggest growth opportunity. Software-application development, integration and maintenance are its primary services to corporate clients, while it pushes into the outsourcing of business processes, such as claims and payroll; the New Jersey-based offshorer also has offices in Europe and Asia, including India. Chung says American employee costs are two-thirds higher than the cost-per-employee in India. While politically unpopular as U.S. unemployment rises, outsourcing certain jobs overseas reduces overhead and saves money: major corporate priorities right now.

The stock has been halved since late last year, trading last week near 17. Cognizant's exposure to financial companies is the main worry. But solid financial concerns, such as Met Life and Credit Suisse, remain clients. Chung thinks revenues and profits can grow 20% in 2009, pushing the shares back to the 27 to 35 range. Price also owns Cognizant because he likes anything that "saves people money."

Slow consumer spending won't prevent Chung from snapping up a potential bargain — Apple below 100. (It was at 96.38 at Friday's close.) "We've seen all of the [negative] consumer data, but you don't get many [affordable] opportunities to buy a large-cap, highly liquid leader in its field with such a pristine balance sheet," he says. Apple's cash balance of $25 billion, which is about 30% of the company's market cap. Chung predicts that calendar-year 2009 earnings will rise by 22% to about $6.25 a share. The shares should trade in the 150 to 180 range due to strong cashflow from the iPhone.

Price suggests that Amazon.com's efficient-retailing model becomes more valuable when consumers are scrimping and gas prices are high. "I think people under-appreciate the advantages it has in its logistics," he says. Amazon doesn't have stores, has easy-to-use software, owns technologically advanced warehouses and has developed sophisticated picking, packing and shipping methods, which benefit both it and the cash-strapped customer.

Revenue growth will certainly slow from its recent 30% rate, he says. But at least the Seattle e-tailer will emerge stronger when good times return. He sees Amazon's market value, now $20.8 billion, hitting $30 billion within five years. Google is another favorite of Price's. He believes it can grow 20% annually for years to come. E-commerce, he notes, "is just getting started" in a lot of countries, and Google will grow faster than the average of those e-commerce markets, says Price.

"People do a lot of research on the Internet before they buy things" which allows for more brand advertising. Plus, "the best way to monetize the mobile Internet is search," which is Google's strength. "I think that the stock could go back up to 600," from its recent 339, Price says. The shares right now carry an earnings multiple of 15 times 2009 estimates of $22.62.

Nintendo's refreshed product line-up and demand for its popular, interactive Wii consoles give the computer-game maker a leg up on the competition, Alger's Chung says. A new DS (dual-screen) handheld-computer game with increased wireless capability and steady demand for the Wii version of the extremely popular Guitar Hero game also bode well.

While demand for computer consoles and game software will fall, Nintendo has an advantage: Its products cost less to make than Sony's Playstation or Microsoft's Xbox. And high license fees charged to third-party game developers provide an added revenue cushion. "Nintendo fundamentally is a striking opportunity," Chung says.

The shares trade at around 14 times fiscal year 2008 earnings, and Chung predicts that the company will double FY 2009 earnings to $4.27. Plus, the company has roughly $11 billion in net cash, about a quarter of its market cap. Chung sees the shares hitting the 55 to 65 range within a year, up from near 39.