Remember the 1990s? Everyone was looking ahead, either fearfully or hopefully, to the new millennium, and tech stocks were the golden child of the era. Many investors were hoping to fund their retirement with the proceeds of a few tech investments that they expected to keep rising into infinity. It was, after all, a "new paradigm."
However, the tech market crash of 2000-2002 soon brought many of those dreams to an end. And while some firms have recovered and gone on to reach new heights, many tech stocks are still trading below where they were at the height of the tech bubble. But don't count technology down and out just yet -- if you do, it may cost you in the end.
Back in the saddle
There are two sectors that I think are destined for greatness in 2010 and beyond -- health care and technology. While the demographics are firmly behind the bullishness on health care, the looming cloud of government regulation is still an unknown for the sector. On the other hand, technology isn't facing quite so many headwinds.
In response to the recent financial downturn, companies slashed tech spending to the bone in an effort to rein in costs. However, firms cannot put off upgrading old equipment and technology forever, and that means there's a tremendous backlog of demand building for the tech sector. As the economic recovery firms up, odds are good that we're going to see a burst of activity in tech buying as companies finally feel secure enough to spend again.
Beyond that, future trends point to even more potential for the sector. Some are saying that the next major tech cycle will involve wireless Internet and may even exceed the initial Internet cycle of the late 1990s. According to a recent report by Cisco Systems (Nasdaq: CSCO ) , while global Internet traffic is expected to grow at a 38% annualized rate through 2013, mobile data traffic is expected to grow at a 131% rate each year, thanks to the increased penetration of smartphones. That means companies such as Apple (Nasdaq: AAPL ) and mobile software developer Sybase (NYSE: SY ) are in the ideal position to benefit from this global trend.
Value re-emerges
Apparently, I'm not alone in my optimism on the information technology sector. In a recent letter to shareholders, the management team at Dodge & Cox highlighted the fact that after many years of avoiding the overpriced health-care and technology sectors, they were suddenly finding these areas ripe with value. The potential growth of the technology arena is simply too powerful to ignore. The team at Dodge & Cox is seeking to capitalize on these trends by investing in financially stable industry leaders with strong intellectual-property portfolios, such as Hewlett-Packard (NYSE: HPQ ) , eBay (Nasdaq: EBAY ) , and Computer Sciences (NYSE: CSC ) .
The tricky thing with buying tech is that many of the companies in this area trade at lofty valuations, at least with respect to traditional price-to-earnings measures. As the folks at Dodge & Cox have advocated over the years, valuations are extremely important, and given that economic growth is likely to be lean in the immediate future, overpaying for growth isn't likely to work as a long-term strategy. That means investors need to consider tech names that are selling at discounted prices, such as Microsoft (Nasdaq: MSFT ) , which clocks in with a very reasonable 16.1 price-to-trailing-12-months earnings ratio. So be sure to do your homework when it comes to current prices.
Get in while the getting's good
If you're a stock picker, now is an ideal time to stock up on some tech names that are selling on the cheap. Odds are good that the bargains won't be around forever, especially once the economic recovery takes hold. I don't expect outsized returns for the equity market as a whole this year, but reasonably valued tech names should do quite well.
If you're not up for the time and effort involved in individual stock picking, mutual funds are the way to go. If you own a few large-cap funds, odds are you already have some decent exposure to the tech sector. Managers across the board are adding to this sector, so you won't miss out on a resurgence in tech.
If you're looking for more dedicated exposure, consider a low-cost exchange-traded fund dedicated to this sector, such as the iShares Dow Jones US Technology ETF (NYSE: IYW ) . If you go with a dedicated fund like this, be sure to keep your allocation very low, less than 5% of total portfolio assets, to avoid any unexpected blow-ups.
Overall, I think good things are in store for the information-technology sector in the coming years. Investing in this arena definitely won't be a smooth ride, but for long-term, patient investors, the payoff could be well worth it.
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