Two Cheap Tech Gems

04/26/2010 10:25 am EST

Focus: STOCKS

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says some technology stocks are still reasonably priced even after the big market rally, but you have to choose carefully.

Despite [big] gains, you can still make the case that many tech stocks are cheap. Hardware and software stocks tracked by Thomson Reuters trade for prices that are about 1.5 times higher than their expected profits per share for the coming 12 months.

This key value measure, known as the forward price-earnings ratio, is near all-time lows. It's 18% cheaper than the ratio for the Standard & Poor’s 500, compared with an average discount of 2%.

Still, with many tech stocks already way up, a lot of experts say it's too late to shop the big names or simply buy into the sector. Instead, you need to cherry-pick.

The key is to find lesser-known names priced cheaper than most, left behind by the rally for some reason and likely to catch up.

Chances are good that something near you right now contains a chip made by ON Semiconductor (Nasdaq: ONNN). That's because the company sells more than 30 billion processors a year [for] PCs, notebooks, computer monitors, TVs, DVD players, cars, clocks, home security systems, and cockpit displays.

Even though sales of products like computers and cars (in China) using ON’s technology are booming, the company trades for a forward price-earnings ratio of just [nine times]. It has a P/E-to-growth, or PEG, ratio of only 0.9. For high-growth stocks in areas like technology, a PEG ratio of less than 1.5 is considered attractive.
 
One of the reasons ON Semiconductor is cheap is because it got loaded up with debt before it was spun out of Motorola (NYSE: MOT) about ten years ago, and it has bought more than a few companies along the way. But ON produces a lot of cash. Outstanding debt at the end of 2009 was $935 million (with enough cash to cover all but $362 million of that debt), compared with $1.2 billion at the end of 2008.

Meanwhile, profit margins are improving as the company closes plants and moves more production to a cutting-edge factory in Gresham, Ore. It is also gaining market share in desktops, notebooks, the automotive sector and mobile phones. (ON closed Friday slightly above $8.50—Editor.)

Brocade Communications Systems (Nasdaq: BRCD) sells switches used to connect servers and storage networks in data centers. The company has had trouble managing its 2008 acquisition of Foundry Networks, which makes switches and routers. So, its stock got pummeled in February after a bad earnings report.

Now at [around] $6.50 a share, Brocade trades for just ten times earnings, well below the P/E of 15x that investors assign to Cisco Systems (Nasdaq: CSCO), which also sells equipment used in communications networks.

But Brocade remains a major player in the market for switches that direct traffic in data centers. This is an area that should get a boost as companies increase spending on tech infrastructure.

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