This week I’d like to coddiwomple through making mistakes and staying data-dependent to gain a...
Yes, the NASDAQ is higher than it's been since the tech bust of 2000, but this is a different and much healthier technology sector
03/16/2012 8:30 am EST
But breaking the 3,000 level isn’t either a signal to put the champagne on ice so it will be chilled when it’s time to celebrate the NASDAQ hitting 5,000 or to run in fear yelling “The sky is falling again.”
Truth is, this isn’t your father’s technology sector. We’re not headed to the moon or into the abyss. Which is why even at 3,000 this is a good time to invest in technology stocks. As long as you understand the big differences between the current technology market and that of 2000.
I can think of four major differences.
First, the shares of the big established technology companies are much cheaper now than they were in 2000. To take the extremes, look at Cisco Systems (CSCO) back then and Apple (AAPL) now. In April 2000, just as the bubble had started to burst, Cisco Systems sold at a price-to-earnings ratio of 199.84 based on trailing 12-month earnings. Apple’s March 14 price-to-earnings ratio on trailing 12-month earnings is just 16.63.
And Cisco Systems and Apple aren’t simply isolated instances. Marc Faber calculated in the fall of 2000 that the NASDAQ as a whole traded at 240 times projected 2000 earnings per share. The New York Times, working the numbers today, gets a 2000 price-to-earnings ratio of 155. (The difference, I think, depends on how you treat companies with no earnings and therefore infinite price-to-earnings ratios. There were a lot of those in 2000.) The current NASDAQ price-to-earnings ratio is below 20, according to the Times.
Today’s technology sector is simply just not as dangerous as the sector was in 2000. Yes, technology stocks could fall from today’s 3,000 level but the drop would likely be a correction and not the kind of plunge that we saw from 5048.62 on March 19, 2000 to 1114.11 on October 9, 2002.
Second, the big companies that dominate the sector’s market cap now are a lot more mature than these same (and other now departed) big cap companies were in 2000. That means more earnings to support prices and price-to-earnings ratios in the sector—and also lower earnings growth rates because bigger companies, by and large, don’t grow revenue or earnings as fast as small companies.
Look at the projected annual growth rates for these big technology giants in the 2012 market. Intel (INTC) is projected to grow by 9.9% annually over the next five years. Microsoft’s earnings will grow, it’s projected, 8.8% a year over the next give years. Cisco’s earnings growth is projected at 8.4% annually over the next five years.
These are the kind of growth rates you expect from companies such as Coca Cola (KO), McDonald’s (MCD), and Wal-Mart (WMT.) Wall Street projects five-year annual earnings growth for those companies at 8%, 9.6%, and 10.6%, respectively.
Even if you go down a level in size from these tech giants to a faster-growing part of the sector, you won’t find the kind of projected growth that Wall Street publicized for the sector in 2000. F5 Networks (FFIV) is looking at 21.9% annual earnings growth over the next five years. Qualcomm (QCOM) is projected at an annual 15.4% growth. Broadcom (BRCM) earns a 14.6% annual growth estimate.
One of the costs of the sector’s greater maturity is slower growth. The lower price-to-earnings ratio for the sector now from 2000 levels is to a large degree justified.
Third, if you’re looking for excess, the place to look for it in 2012 as in 2000 is in the initial public offerings in the sector. But even there, 2012 takes a back seat to the excesses of 2000.
Amazon.com (AMZN) went public in May 1997. Despite a $6 million loss for the previous 12 months, the company finished its first day valued at $438 million. eBay (EBAY) went public in 1998. That company had $1.2 million in profits in the previous 12 months. The first day market cap came to $1.9 billion. That comes to a price-to-earnings ratio of 1583.
In contrast recent flashy IPOs like Groupon (GRPN) and Zinga (ZNGA) have earnings and lofty but not mindboggling price-to-earnings ratios. Groupon trades at 81.54 times projected 2012 earnings and Zinga goes for 51.74 times projected earnings. Even Facebook, which is projected to go public in May, doesn’t hit the eBay scale. The company had $1 billion in earnings in 2011 and is projected to go public with a market cap of $100 billion for a price-to-earnings ratio of just 100.
One of the reasons for the ratcheting down of expectations is because of the experience of 2000. Amazon and eBay and even companies such as GeoCities and Broadcast.com all looked like they would change the U.S. economy. Amazon and eBay would revolutionize retailing, for example.
Now, there’s a lot of excitement about the initial public offerings of companies like Groupon and Zinga and Facebook but the expectations are actually more modest. The market sees these companies as extraordinary new advertising and marketing vehicles, for example, but they’re an incremental step—perhaps a huge one and perhaps not—from Google (GOOG.)
Fourth, if I can vastly over-generalize, technology in 2012 feels much less revolutionary, disruptive, and creative/destructive than 2000. Amazon did indeed revolutionize retailing and the landscape is littered with a still growing trail of the corpses of companies that couldn’t compete ranging from Borders to Circuit City. I’d be surprised if the next five years didn’t see an obituary for Sears (SHLD) or Best Buy (BBY) or Barnes and Noble (BKS) or some other retailer.
In 2000 Cisco and its Internet equipment fellows did kill Lucent Technologies and Nortel, two of the really big players in telecom equipment. Wireless phones powered by companies such as Qualcomm did force phone giants to become wireless giants.
There’s certainly a fair share of destruction going on today. Hewlett-Packard (HPQ), and Yahoo (YHOO) are fighting for relevance. Nokia (NOK) is fighting to re-invent itself. Intel and Microsoft (MSFT) are struggling to make their traditional strengths count in a new environment.
But with the exception of Apple no technology company in 2012 looks like will reshape the competitive playing field like Amazon did in the technology wave that peaked in 2000 or as Google (a 2004 IPO) did slightly later. (And there are those who doubt even Apple’s credentials as a game changer, saying that the company is simply better at exploiting existing trends rather than at creating new trends.)
Many of the most interesting companies in the 2012 technology wave seem instead pick and shovel builders (Rackspace Holding (RAX), for instance), or exploiters of new platforms (Groupon), or extenders of business strategies (Facebook from MySpace, for example.)
What does this extended comparison suggest about investing in technology now?
- That investing in the big mature technology companies isn’t just about growth anymore. It’s about dividends (Intel pays almost 3%.) It’s about the trade off of predictable earnings and lower earnings growth where predictability contributes a substantial portion of the stock’s valuation, just as it does with Coca Cola or Procter & Gamble (PG.) And it can even be about value. In fact, two of the most interesting big mature technology stocks in this market are value plays. Microsoft trades at just 12.1 times trailing 12-month earnings. Don’t forget to throw in Microsoft’s 2.2% dividend yield. What makes that valuation so interesting is the introduction of the Windows 8 operating system (including a version for for tablets) and the first update of its new Windows Phone operating system (Windows Phone 7.5 or Mango) both due this fall. The new operating systems embrace touch screen user interfaces, cloud computing, instant-on, and lower power consumption that, on the evidence of Nokia’s new phones using Windows Phone 7, could make Microsoft a strong No. 3 in the wireless phone and tablet markets behind Apple and Google’s Android. That would be quite an achievement for a company considered irrelevant in those markets just a year ago. Standard & Poor’s projects that Microsoft’s earnings in the fiscal 2013 year that begins in July 2012 will climb by 12.5%. And Microsoft’s success makes Nokia’s save-the-company bet on switching to Windows Phone seem like a gamble that’s got a far better chance to pay off than skeptics initially imagined. Nokia is still bleeding market share as fewer and fewer customers want to buy a phone with the soon-to-be discontinued Symbian operating system. Nokia’s revenues fell 5% in 2011 and are forecast to drop another 3% in 2012. But that’s actually progress and Credit Suisse, one of the few Nokia bulls, believes that the company’s share of the wireless phone market will stabilize near 13% in 2013.
- If you’re looking for something closer to the earnings growth rates of the 2000 wave of technology stocks, think smaller and more focused rather than bigger. F5 Networks, a networking company with a much tighter focus than Cisco, is growing about twice as fast. LSI (LSI), a chipmaker that specializes in high-end storage and networking chips, is forecast to grow earnings by 24% in 2012 and 34% in 2013. That’s a bit better than the 9.9% annual growth projected for Intel over the next five years. VMware (VMW), a maker of virtualization software, is forecast to grow earnings by 24% annually over the next five years versus 8.8% annual growth for Microsoft.
- If you’re looking for technology companies built around new ideas don’t forget the companies that enable bigger technology trends. Aruba Networks (ARUN), for example, specializes in hardware and software that let mobile devices—such as iPhones—securely access corporate networks. Digital Realty Trust (DLR) owns a portfolio of 102 data centers in 31 markets serving clients that include Facebook, AT&T (T), and Morgan Stanley (MS). Organized as a REIT (real estate investment trust) Digital Realty pays a 3.8% dividend. Apple (AAPL) is a 10% customer at Broadcom (BRCM) and Credit Suisse estimates that the chip company has $6 to $10 of its products inside every iPhone and iPad.
- That if you can get in (because you’re Uncle works at one of the underwriters or because you’re broker really really likes you and the fees you pay on your account) on a hot technology IPO, do so—and flip it. Nobody is getting the 250% first day gains that investors in Broadcast.com reaped on its first day of trading, but the 109% jump in the price of LinkedIn (LKND) on its May IPO is still decent pocket change. Just don’t stick around too long. The stock fell to $70 on November 21 when the 6-month lock-up period expired and company insiders were able to sell shares.
And, of course, don’t forget about Apple itself, the poster child for technology in this market. The stock at $585 at the close on March 15 is getting close to the $650 level where I think Apple may have to rest and consolidate a new base. So maybe this isn’t the best time to buy Apple. But I think you’ll get a chance during a technology rally that, because it is so relatively modest in its excesses, stands a chance to run for a while.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple and Nokia as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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