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anyone really need proof that the high-tech craze is dead?
If so, it came
with the news that Henry Blodget, the handsome, 34-year-old Merrill
Lynch analyst with the wavy Richard Gere hairdo, was being investigated
by New York's attorney general for allegedly misleading investors.
Merrill was a late convert to Internet stocks, then embraced them
ferociously, putting its imprimatur on such dubious propositions
as eToys and Pets.com (both now defunct) and encouraging its Main
Street clients to get on the Internet bandwagon just as it was headed
for a ditch. Blodget boosted stocks such as InfoSpace Inc., a vendor
of "content" that loses more money every year. InfoSpace
peaked above $250 a share two years ago and now trades at $2.19.
Of course,
Blodget wasn't the only high-tech enthusiast who got it wrong. Mary
Meeker of Morgan Stanley, whom Fortune magazine called "the
unquestioned diva of the Internet age," kept recommending stocks
such as Priceline.com and FreeMarkets all the way down. Priceline,
which traded at $165 in 1999, closed Friday at $5.37.
Since mid-March
2000, the Nasdaq 100 — an index of the 100 largest companies
on that tech-heavy exchange — has fallen 63%, compared with
an increase of 2% for the Dow Jones industrial average. You can
hardly blame investors for never wanting to go near a tech stock
again.
But that would
be a big mistake. Every portfolio needs technology stocks —
for the simple reason that tech still represents a big chunk of
the stock market and is responsible for two-thirds of the growth
in the economy. Here's what to know before you buy:
 Tech
is a sector, not a retirement plan. So diversify. Currently, the
value of all listed tech stocks is a little less than one-fifth
of the value of the entire market, so if you want a portfolio that
looks like the market and the economy, then tech should make up
somewhere between one-sixth and one-third of your portfolio. The
investors who got into big trouble over the past few years were
the ones who loaded up on highflying tech stocks. If tech accounts
for half of your portfolio and the rest is spread evenly over other
sectors, then you are probably down by 20% to 25% this year. If
tech accounts for one-fifth (as it should), then you're down about
12%. If you're still overloaded in tech, pare your portfolio immediately.
Take the tax loss.
Tech
doesn't have a patent on volatility. Practically every sector of
the stock market — from oil service to health care to machine
tools to tobacco — is more volatile than the market as a whole.
Invest in a single sector, or just two or three, and you are assured
of a wild ride. Since the beginning of the year, the Dow has swung
between a high of 11,338 and a low of 8,236. The low, then, was
27% less than the high (think of a stock trading between a high
of $57 and a low of $41 for the year — not particularly volatile).
Using Dow Jones data, I calculated that the low for tech stocks
this year was 60& below the high — very volatile.
But look at
the gas utilities sector, where the low was 74% below the high;
or coal, where the difference was 59%; securities brokers, 53%;
advertising, 47%. So far this year, stocks in the consumer-services
sector are up an average of 54% and water utilities shares are up
40%, but the advanced industrial-equipment sector has fallen 48%
and non-ferrous metals stocks are down 39%.
The message
is that individual stocks and individual industries offer a gut-churning
voyage in the short term. Always. The only way to smooth the journey
is to own a wide variety of sectors, so that the losses are balanced
by gains.
Don't
buy companies that haven't made money. Investors found trouble when
they tried to bet on companies with no history of earnings. This
is not as crazy as it sounds. After all, economists say that the
value of a company's stock is determined by the sum of all the earnings
the firm will glean over its lifetime. It's the future that counts.
That's true, but there's no way to tell the future, so the best
evidence we have is the past, and a history of losses is not very
reassuring. Venture capitalists who know a firm inside out can make
high-stakes gambles on companies with no profits, but small investors
absolutely should not. Blodget was fond of InfoSpace even though
it lost $29 million in 1998, then $80 million in 1999, then $280
million in 2000. The company will lose money again this year. Who
needs it?.
Not
all high-tech companies are clunkers. Back on April 27, 1997, I
wrote about a remarkably simple system for investing in tech stocks,
developed by Leslie Douglas of the venerable Washington firm Folger
Nolan Fleming Douglas. Under the Douglas Theory, you put equal amounts
into the five largest stocks — in terms of market capitalization
(or value according to investors) — on the Nasdaq. At the time,
those stocks were Cisco Systems, Intel, Microsoft, Oracle, and MCI
(later merged into WorldCom). In the 4 1/2 years since, this portfolio
of five high-tech companies has returned 148% while the Dow has
returned just 44%.
Finding
the Winners
Many tech stocks have been huge long-term successes. An investment
of $1,000 in Dell Computer Corp. in 1991 is worth more than $100,000
today. Cisco, despite falling by three-quarters from its high in
2000, has still returned more than 15,000% in the past decade. Adobe
Systems Inc. has lost two-thirds of its value since late 2000, but
it's still up 237% over the past five years. Like any other sector,
tech has winners and losers.
How to find
the winners? The standards are the same you should apply to any
company: a strong record of rising earnings, a solid balance sheet,
strong management, top-notch products that are not apt to draw a
lot of competition, and a decent stock price. In fact, Adobe, maker
of such software as PageMaker, Photoshop, and Acrobat, may be a
good choice. The firm has been profitable since 1986, with earnings
rising in every year but one since 1992. Adobe has no debt, $576
million in cash, and profits that have been increasing at a 16%
rate over the past 10 years and are estimated by Value Line to do
even better in the five years ahead. The stock, however, has dropped
by more than half from its 12-month high and trades at a price-to-earnings
(P/E) ratio of 30. It's not exactly cheap, but it doesn't seem overpriced,
either.
Another profitable
high-tech company is VeriSign, whose earnings jumped from $0.03
a share in 1999 to $0.48 last year to an estimated $0.65 in 2001
and $1.16 in 2002. VeriSign is the exclusive registry for .com names
through 2007, and it provides digital security for giant customers
such as AT&T, Visa, and Eastman Kodak. The company also has
no debt and a ton of cash, and it closed Friday at $40.99, down
from an all-time high of $258.50 last year.
William Miller,
the generally conservative manager of Legg Mason Value Trust, a
superb mutual fund that has beaten the S&P's 500-stock index
for the past 10 years in a row (and may do it again in 2001), owns
such tech stocks as Dell, Amazon.com, and IBM. Amazon has intrigued
me for years; it is by far the best-run e-commerce company in the
world. Yet, while sales keep rising, profits have been elusive.
Amazon closed at $11 on Friday, down sharply from a high of $113
during the Blodget-Meeker glory days. Miller bought more shares
during the third quarter.
Amazon doesn't
meet our profit test, but the prices of money-making companies like
VeriSign have fallen into the realm of reason. For a company that
could reasonably earn $3 a share by 2005, a P/E ratio today of 60
is not screwy — though the stock is definitely a high-risk
proposition. That's the case as well with attractive software companies
such as Cognizant Technology Solutions Corp. (no debt, a history
of rising earnings, and a P/E of 35) and well-managed computer-system
providers such as Jack Henry & Associates (no debt, 12 straight
years of growing earnings, and a P/E of 31).
Individual
techs are so risky that considerable diversification within a tech
portfolio is essential. An easy way to get it is by owning the Nasdaq
100 Index Tracking Stock, an exchange-traded fund (ETF) listed on
the American Stock Exchange under the symbol QQQ. Think of QQQ as
a mutual fund that owns 100 companies, the vast majority of them
large high-techs. Currently, Microsoft accounts for 12% of the assets;
Intel and Qualcomm, 6% each; Cisco and Oracle, 4% each.
Since its inception
less than three years ago, QQQ has had its ups and downs. In 1999,
it gained 82%; in 2000, it lost 37%; and it's down 32% so far this
year. But for long-term investors, it represents the easiest —
and probably the best — way to own the sector. Expenses are
only one-fifth of one percentage point a year, but, of course, you
have to pay a brokerage commission when you buy.
Don't give
up on techs, but even at these prices, don't get carried away. Your
holdings may be spread out among lots of techs, but your non-techs
should outweigh them in dollar value by 3, 4, or 5 to 1.
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