Beyond Apple, U.S. Tech Companies Get No Respect!

Tech stocks are still being underestimated, even though they’re cheap and America remains the world’s technology leader.

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Technology stocks are having a bad year. Just since August, they’ve lost 6% on average, and many specific companies have fared a lot worse. The most conspicuous exception to this trend has been Apple, which is up 30% over the past 12 months. But how long can that continue? With Steve Jobs gone, Camelot has lost its last knight.

Yet despite its listless performance, the technology sector stands to benefit from a powerful long-term trend. Quite simply, the U.S. remains the world leader in most areas of technology. “But what about America’s irreversible long-term decline?” the naysayers cry. “Sure, the U.S. still excels in the nattering and chattering technologies, like Facebook and Twitter. But in everything else, aren’t we being outpaced from Finland to China?”

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Actually, no. Today’s horrible economy has distorted our view of American tech stocks. If you look back before the recession, some of the people best placed to assess the global technology market concluded that the U.S. was still the leader in most sectors. Deloitte’s 2008 global venture capital survey found that a majority of the 398 VCs who responded rated the U.S. as No. 1 in telecommunications, semiconductors, software, biopharmaceuticals, medical devices and clean energy.

Of course, the global market for technology has grown more competitive in recent years and rivals have been able to run a close second to the U.S. in many areas, and even take the lead in some niche markets. But most American tech companies seem to be coping well. It’s not hard to find companies with strong franchises and solid balance sheets. Indeed, since companies often generate huge amounts of cash once they have a winning product, many top tech stocks have no net debt at all, once their cash on hand is taken into account.

Moreover, if you look at the three chief reasons the group is suffering at the moment, they each turn out to be cyclical – that is, you can expect them to turn around once the global economy finally recovers. Here’s a quick look at each current but ephemeral obstacle:

  1. The shadow of the tech bubble. Technology hasn’t recovered from its collapse more than a decade ago. Stock prices today are less than half what they were in March 2000. But the fact that share prices were grossly overvalued back then proves nothing about the present. If anything, one might conclude that wild over-optimism has been replaced by excessive pessimism. Let earnings start growing again, and tech stocks should perk up remarkably fast.
  2. Postponed demand. Much technology is a form of capital spending, and few businesses want to upgrade and expand when the economy is in the dumps and demand is soft. Makers of microprocessors for mobile phones, for example, may try to get by for a few more years with their old chipmaking equipment. But sooner or later they’ll have to retool – and then producers of chipmaking equipment will prosper. Orders postponed today become additional demand tomorrow.
  3. Historical volatility. Tech stocks are typically more volatile than many other shares and often pay below-average dividends. At the moment, those qualities are unappealing to anxious investors who want low-risk stocks with fat yields that will support share prices in a market downturn. But that will reverse as soon as a solid bull market gets under way. Investors then will be looking for upside.

The bottom line is that tech stocks are undervalued now because they are out of step with the economic cycle. And there’s no telling when the recovery will finally come. Some of the tech stocks I own have been pummeled recently, particularly Juniper Networks. But if you have money that you can invest for three-to-five years, today’s prices will probably look like bargains in retrospect.

For my own portfolio, I’ve generally looked for stocks with little or no debt, more cash on hand than debt, or annual cash flow sufficient to pay off all debt in less than three years. I’ve also favored the shares of companies with fundamentally strong positions in their industries, as well as attractive dividend yields and P/E ratios that seem quite modest.

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Among these stocks are: Applied Materials (AMAT), with a P/E of 11.5 based on earnings for the coming year; Corning (GLW, 7 P/E), Intel (INTC, 9.4), Juniper Networks (JNPR, 12.9) and Microsoft (MSFT, 8.6). For a more indirect approach, you might want to consider AT&T (T) and Verizon (VZ). They lack the strengths of the pure tech plays, but they stand to profit from the steady sale of cellphones, since they provide most of the service for smart phones. And they pay fat yields of more than 5% while you wait for the recovery.

For most investors, though, it probably makes sense to buy shares in a portfolio of big, strong tech stocks through a mutual fund or an exchange-traded fund. One ETF that I like is the SPDR Select Technology sector fund (XLK, 1.4% yield). It holds a broad assortment of the biggest tech names, with an average P/E of 14. A rebound in P/E multiples to the high teens, say, would mean a 30% profit, even before figuring in any earnings growth.

Most investors may have given up on American technology, but to paraphrase Steve Jobs, perhaps you should think different.

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