5 Stocks From the Technology Sector

Though unemployment remains high, the economy is in fact recovering from its worst downturn since World War II. The market reflected that anticipated economic recovery last year as it soared 65% from the March 9 low with the technology sector leading the way. However, this year the market has seen a small correction with the technology sector pulling back slightly more.

While there has been a sell-off in the technology sector this year, it has created opportunities for investors to buy technology companies at better valuations. Some of the smartest investors around see value in the space now, too. In a recent Foolish interview with Mary Chris Gay, co-manager with Bill Miller of the Legg Mason Value Trust index fund, Gay said "we continue to have exposure in technology," remarking that while "that is a little controversial, because that area of the market did very well last year and has sold off this year," she concluded "we believe they still represent among the best values."

If we drill down into the fundamentals, we find out why there is value. Technology has nice prospects as we move into the next phase of global recovery. As businesses begin to regain confidence, technology is proving to be one of the first areas of investment for corporations; technology increases efficiency and enables a company to produce more with fewer workers, which fattens margins for both suppliers and buyers.

According to Charles Schwab, current growth in business investment in technology is now outpacing growth in total business investment. Additionally, Schwab noted that companies put off upgrading systems during the recession and real tech investment has been below average for several years, both of which bode well for the sector. The recession also led companies to hoard cash on their balance sheets and slash expenditures. Thus, they'll be poised to begin fattening up their profit margins once sales kick in, which is finally beginning to happen.

Fourth-quarter GDP showed a 13.3% uptick in business capital spending -- most of which was owed to investment in technology.

Hewlett-Packard (NYSE: HPQ) serves as a tangible example. The company's earnings shot up 25% in its fiscal first quarter on an 8.2% increase in revenue. The quarter marked the first time in a year the company has booked revenue growth, perhaps showing that technology spending is back. The world's largest computer maker saw sales in its PC division rise 20% for the quarter. Company executives noted that PC prices stabilized since the first part of 2009.

Adding to the encouragement that tech spending is picking back up, Cisco Systems (Nasdaq: CSCO) also reported revenue growth in its latest quarter, the first time since early 2009.

Given these improving conditions, investors should consider adding exposure to technology in their portfolios.

To that end, I turned to the CAPS screening tool to uncover strong tech companies potentially poised to take off. I screened for companies in the technology sector with:

• CAPS ratings of four or five stars, the highest ratings from our CAPS community.
• A current ratio of 1 or greater, meaning the companies would be able to cover their near-term obligations at least one time over.
• Minimum market cap of $200 million.
• Return on equity of 15% or greater.

Here's what my screen turned up:

Source: Motley Fool CAPS as of Feb. 22. TTM = trailing 12 months.

Like any investing argument, this one comes with potential pitfalls. Even with a recent pullback in the overall sector, it's important to make sure that valuations haven't pushed prices too far ahead of technology companies' individual financial prospects. This will differ from company to company.

Additionally, a "double dip" in the economy, while unlikely, could shut off spending plans. Alternatively, a slow-growth scenario could temper investment. A strengthening dollar could have an effect as well, as many tech companies derive a substantial portion of their revenues abroad. Global competition, particularly from the Asian Tigers, is a consideration as well. Will the global recovery remain intact, especially with structural issues that engulf the developed world -- particularly Europe?

Risks aside, the prospects for the tech sector as a whole are bright. When considering a technology company, ask yourself: Is this company fundamentally strong? Are broader economic conditions the only thing suppressing revenue? Is the company well-positioned in the marketplace? Is it picking up market share? If you answer "yes" to those and similar questions, you might just have a winner.

Use the Motley Fool CAPS screener and our entire community-intelligence database as a first step in your investment research on technology stocks. The collective wisdom of our 150,000 members can help you make better investing decisions.

For more tech Foolishness:

• Microsoft Bullies Amazon
• Is Google Finally Evil?
• How to Invest Right Now