Tech Titans Are on Sale

Many people learned just how risky technology stocks can be during the 2000-2002 bear market. The tech-laden NASDAQ Composite index plunged a staggering 74%. The index today still trades more than 60% below its March 2000 peak.

But tech stocks in 2000 sold at ludicrously high prices relative to their earnings and sales. Many companies changed at hands at 100 or more times earnings for the preceding 12 months. Others had no earnings at all, and some didn’t even have any revenues.

Today’s market presents a starkly different picture. The biggest tech stocks, on average, trade at about 15 times trailing earnings. They’re no more expensive than the rest of the stock market—even though tech stocks may well offer more potential for earnings growth than stocks in many other industries.

The technology industry has matured during the past decade. True, some startups still trade on little more than a hope and a prayer. But many technology companies have built sturdy businesses that competitors would have an extremely difficult time taking away. They own valuable patents that enable them to raise prices without losing customers.

What’s more, these tech titans have two commodities in scarce supply just now: little, if any, debt and piles of cash that can be used to grow their businesses or acquire weaker competitors. They’re not reliant on the banks or the markets to raise money—a huge advantage given continuing tight credit.

As the recession has deepened, many companies in a variety of industries have postponed buying new technology equipment and services. But eventually businesses will be forced to invest in new technology to bolster profit margins.

For all these reasons, technology stocks look extremely attractive. Don’t make the mistake of putting too much of your stock money into one sector, but investing 25% or so in technology stocks through diversified funds, technology funds or tech stocks could help your returns—whether the market goes up or down from here. Tech stocks exemplify the high-quality stocks that I think make the most prudent investments in today’s still fragile environment.

How to invest in technology

The simplest way to invest is through a mutual fund or exchange traded fund (exchange traded funds or ETFs are simply mutual funds that you buy on a stock exchange through a brokerage account). My favorite regular fund is T. Rowe Price Science & Technology (tel. 800-638-5660, symbol PRSCX). Baltimore-based T. Rowe does a solid job investing with virtually all of its funds. Expenses are 1% annually.

The better choice in technology, however, may be an ETF. Vanguard Information Technology ETF (VGT) charges just 0.2% annually and is dominated by such tech stalwarts as Microsoft (MSFT), International Business Machines (IBM), Cisco Systems (CSCO) and Apple (AAPL).

September 3, 2009

—Steven T. Goldberg