Strike up the Tech Band

06/02/2006 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

"Can you handle some shocking news?" asks Richard Band. "Technology stocks are stirring in their tomb! Given up for dead after the Internet bubble, many are quietly moving into position to trounce the market averages in the months and years ahead."

"Why will investors flock back to technology? Basically, for two reasons. First, technology companies hold out the prospect of growing their sales and profits faster than the general economy for years to come. Technology is still America’s trump card in world trade. Over the long pull, businesses that grow rapidly and consistently build the greatest wealth for their shareholders.

"Six years in the doldrums have left many tech stocks remarkably cheap in terms of their present and future earnings power. After the bubble burst, the strongest technology companies regrouped, restructured and have now returned to healthy profit growth. Yet their share prices haven’t kept up. As a result, the stock market is now valuing some of the world’s finest tech businesses at their lowest price earnings multiples in many years.

"With plenty of attractively priced tech names to choose from, we’ve got a challenge on our hands—to winnow the list down to the stocks with the biggest potential reward for a moderate degree of risk. Here are two we’re buying for the model portfolio:

"I’m willing to bet that Microsoft (MSFT NASDAQ), the #1 software maker, which has cranked out an awesome $13 billion of free cash flow in the past four quarters, will continue to allocate its capital wisely. A new version of the company’s flagship Windows operating system will hit the streets within the next year, stimulating sales. Meanwhile, Mr. Softee is reporting impressive growth in server software and the home-and-entertainment (Xbox) division.

"Let’s not forget the price of the stock, either. Microsoft is now at its lowest p/e ratio in many years. How many other blue chips do you know of that are this ‘sold out’? For those of us who treasure dividends, the company also now pays one (current yield 1.6%). One of my favorites, MSFT generates an astonishing $1.1 billion of free cash flow (after spending on capital projects) every month. Yet the shares are trading at their lowest price-earnings ratio in many years. Do I smell a double? Probably within three or four years, and maybe a lot sooner.

"EMC Corp. (EMC NYSE) is much smaller than Microsoft, but not exactly flea-sized at $30 billion of stock market value. It is the world’s pacesetter in data storage. As more and more commerce migrates to the Internet, the need for storage is exploding. The analyst community is looking for EMC’s profits to jump 30% this year—and the estimates keep rising. At just 18 times this year’s projected net, EMC is conservatively priced for a business on a steep growth trajectory.

"What’s more, EMC boasts a fortress-like balance sheet, with enough cash and investments to pay off all the company’s bills immediately, if necessary. Small wonder EMC has decided to buy back $3 billion worth of stock in 2006—triple the amount repurchased last year. (Every share that disappears makes the remaining stock more valuable.) Although EMC doesn’t pay a cash dividend, the buybacks serve as welcome substitute."

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