Get Rid of Your Tech!

The pundits are saying "Sell tech" because it's too expensive. Sure, some tech companies sport massive P/Es, but that's to be expected in a time when earnings have dropped to negligible levels. Once again, the pursuit of hot headlines is trumping the need to provide even marginally useful investing information. When a talking head starts to knock an entire sector, Bill Mann starts licking his chops.

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By Bill Mann (TMF Otter)
June 18, 2002

The majority of people should not buy individual equities.

I guess there is something to the thought that there is nothing as painful as love unrequited. Much of the American investing public, for much of the 1990s and on into this past year, has viewed high technology companies as the drivers and most important components of the U.S. stock market. At one point in 1999, five companies -- Microsoft (Nasdaq: MSFT), Cisco (Nasdaq: CSCO), Intel (Nasdaq: INTC), Oracle (Nasdaq: ORCL), and Sun Microsystems (Nasdaq: SUNW) -- comprised more than 40% of the entire market capitalization of the Nasdaq stock market. How many of these did you hold during the heights of the stock market?

Along with other big stock market casualties such as AOL Time Warner (NYSE: AOL), Yahoo! (Nasdaq: YHOO), and Nortel (NYSE: NT), these companies are among the greatest symbols of the dream of easy wealth, now deferred. Microsoft, the best performer of the above list since the beginning of 2000, is only down 50%. The others are down much, much more. Interestingly enough, the biggest sentiment about such companies, in fact about all technology companies, is that, even after such a massive dropoff in price, they are still extremely expensive. This sentiment can best be spelled out by two words: "Sell tech."

That's right. Not one of these companies has held on to 50% of its peak market value, but now is the time to sell, apparently. But would you not think that some of these companies are growing quite cheap after such a big haircut? I doubt you could say that too many of them are bargains, but doesn't it seem odd that, where almost no one had anything bad to say about an Oracle in the late '90s, now people do not seem to want it at any price?

Somewhere in here is room for a variant perception, one that I'm pretty sure will be fruitful for the enterprising investor. Not for all of these companies, perhaps -- in fact, for none of the ones named above. But whenever there is a consensus among pundits and market participants that a company, a sector, or a super-sector in the form of "tech" is to be avoided, one can be sure that some good strong candidates are slipping through the cracks. They do so for the very same reason that companies in a given sector rise as a group in the first place: Investors fail to discriminate.

The question thus becomes identifying the companies that a) have good prospects and b) are cheap. What one does not want to do is make "buy" and "sell" decisions based upon generalities, which, unfortunately, is exactly what the majority of the CNBC-addicted crowd does. Instead, one must be willing to dispense with the conventional wisdom, the garbage that is being paraded around as investment advice, and figure out these things for one's self.

There is a reason that Wally Weitz, the legendary value investor and manager of the Weitz Value Fund, has 17% of the fund's money in telecommunications companies including Qwest (NYSE: Q), Citizens Communications (NYSE: CZN), and Level 3 (Nasdaq: LVLT). He's not buying the telecommunications sector -- he's buying companies within that sector that he believes offer compelling value.

So, while the princes and archdukes of the Kingdom of Prevailing Wisdom spew out, well, prevailing wisdom, perhaps the better bet for you is to seek out where that wisdom is, well, wrong. There are some points to consider in determining whether you want to head for the exits along with all the "We're ready to believe you" lemmings. And, bear in mind, it is possible to make an informed decision to bail from this entire sector and be doing the right thing for yourself. The key word there is "informed."

1. This too shall pass. The companies building out our technology infrastructure got so excited from about 1995 to late 2000 that they went ahead and spent the money that would, under less-enthusiastic environments, have been spent over a much-longer period of time. Even though the economic returns for networking companies have yet to manifest themselves, the basic fact is that usage of the Internet continues to grow very rapidly. Just the same, though the wireless web in its many manifestations has been a total disaster to date, there should be little doubt that it is coming (eventually) and that commercial applications may outweigh consumer ones.

2. Don't overemphasize P/E. Once upon a time, the Standard & Poor's Stock Guide would demur from assigning price-to-earnings ratios that exceeded 99. Instead, it would just use the words "very large." I like that, but in a day and age in which P/Es of 1,000-plus are a recent memory for some tech stocks, such a notion seems somewhat quaint.

Obviously, we'd like to be able to purchase companies as inexpensively as possible, and the P/E is a tried-and-true gauge of just that. But remember that we have just endured a wrenching slowdown in capital spending, and some companies are deep in revenue troughs. Moreover, companies are having to write down investments they made during more ebullient times, and these actions are directly affecting reported earnings. I am not suggesting that investors go with such tooth-fairy notions as EBITDA, but recognize that a company can sport a P/E even above 100 and still be pretty cheap once you figure out the economics.

I'd suggest averaging out several years' worth of earnings and then seeing what the company's multiples look like. Applied Materials (Nasdaq: AMAT), for example, has a reported P/E of nearly 2,000. Take a longer period of time to smooth out some business cycles and the company is priced at less than 40 times earnings. Intel drops from an 81 to a 23. These longer-term P/Es are quite rough and in no way should signify that I think these issues are bargains. But when one takes earnings from a trough, one should not extrapolate them.

3. Watch that cash. Some companies, such as Lucent (NYSE: LU) and a full two-thirds of all telecom carriers, are simply running out of time. They lack the ability to wait out the tough times because their balance sheets are in shambles. Over the weekend, yet another former Master of the Universe, Qwest CEO Joe Nacchio, resigned under the strain of an investor base that had tired of his empire-building, $26 billion debt-growing, no-profit-making reign at the company.

Qwest, like its brethren WorldCom (Nasdaq: WCOM), is left to sell assets -- profitable ones -- in order to manage its debts. There are companies in this realm, though, that have shown fiscal responsibility and as such are well suited to ride out the down cycle as long as it lasts. These companies, such as Swisscom (NYSE: SCM) and Cable & Wireless (NYSE: CWP), are in no danger at all of becoming the next Global Crossing, or even the next WorldCom. Will not happen. And yet these companies have dropped like all the rest of this much-hated sector.

4. But... None of the above is intended to provide you with the courage to hold out. Even when the economy rebounds, there are many, many companies that will not join in the fun. If you do not understand the companies you own, if you have no idea what the company's business prospects are, then GET OUT. Technology companies are just that: companies with extremely complex goods or products, for which most investors have no ability to assess competitive positioning, product cycles, or other crucial aspects of the technology. If your rationale for still holding Juniper (Nasdaq: JNPR) amounts to "the Internet's gonna be big," then you might as well either set your money on fire right now or move on to a company on which your insights run deeper.

While some high P/E stocks may have deceptive profiles, it also bears warning that, in general, companies with higher P/Es must grow significantly faster and longer than lower P/E companies in order to reward investors. If the homework involved in making that determination does not interest you, for once I would suggest that the talking heads are giving you some sound advice. Sell. You'll sleep better.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

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Bill Mann's just been introduced to the evil genius that is "fish sauce." At time of publishing, he held beneficial interest in Cisco, Cable & Wireless, and Level 3. The Motley Fool has a comprehensive disclosure policy.