The problem with bubbles is that they are, by definition, hard to spot except in hindsight. Only a handful of people saw the real estate bubble before it burst, and half of those say they see leprechauns, too. But you can find interesting stocks in the wreckage of a bubble, even many years after the bubble has burst. So today we're going to take another look in the still-smoking crater of the great technology bubble of the 1990s.
The tech bubble was remarkable for its breathtaking arc. Companies with no earnings — frankly, sometimes just two guys and PC — doubled and tripled on their initial public offerings. And legitimate companies, such as Juniper Networks and EMC, remain more than 50% below their bubble-era highs. From March 31, 2000 through Oct. 31, 2002, the Wilshire 5000 Total Market index vaporized $6.8 trillion, most of it in the technology sector.
But some tech companies have not only survived, but prospered. And, while there are always ebullient tech sectors, many of the biggest survivors are not only thriving, but relatively cheap. These companies were overestimated in the bubble, and have been underestimated — or dismissed as old technology — in the subsequent recovery.
A quick glance at the Nasdaq 100 stock index will show you how decidedly un-bubbly most of the technology world is these days. The index tracks the 100 largest companies listed on the Nasdaq stock exchange (banks are excluded). Brian Mackey, analyst at Adviser Investments, points out that the Nasdaq 100's price-to-earnings ratio has dropped from an average 42 times earnings in 2000 to 21.5 now. The PE ratio measures a company's pr! ice, relative to earnings: Lower is cheaper, and 42 times earnings is nosebleed territory.
Not only that, but 95% of Nasdaq 100 companies are profitable now, vs. just 67% in 2000, and total earnings from in the company have tripled, from $60 billion to $180 billion. Some people really do learn from experience.
And despite the tech sector's excellent performance last year, it still lagged the Standard and Poor's 500 stock index. S&P's information technology index gained 28.4%, including reinvested dividends, while the S&P 500 gained 32.4%. "I don't think there's a bubble overall in technology," says Paul Meeks, portfolio manager at Saturna Capital. Some areas, such as 3D printing, are "priced like it's 1999," he says. But that's typical with the tech sector.
What is unusual is value managers like Meeks taking a hard look at undervalued tech stocks, many of which are old-school tech stocks that are trying to reinvent themselves. These companies' stocks sell for relatively low PEs, have tons of cash, and even pay decent dividends.
Consider Microsoft, currently selling for 13.7 times its previous 12 months' earnings. The company has a dividend yield of 3.1%, currently about a percentage point more than the S&P 500. Earnings per share grew about 18% the 12 months ended September — nothing like its halcyon days, but certainly respectable.
And then there's Intel, which has flatlined on earnings per share, but has a 3.4% dividend yield and sells for 13.4 times earnings. "These are old-school companies that aren't getting much love on valuations," Meeks says. "But if they're able to transition to new schemes, they could be bargains." Both companies, incidentally, have mountains of cash to spend on new ventures.
Both companies, too, are aggressively shrinking the number of shares they have outstanding. Intel had 5.6 billion shares outstanding three years ago; it's down to 4.9 billion now. Microsoft had 8.6 billion shares outstanding three years ago, vs. 8.3 bi! llion now! .
Other tech companies with dividend yields above 2% and rated above average by Standard and Poor's:
• Apple, currently yielding 2.2%. PE: 14.0.
• IBM, yielding 2.0%. PE: 14.4.
• Cisco, yielding 2.6%. PE: 12.6.
The problem with undervalued stocks, of course, is that they can be undervalued for good reason. Given that these companies have enormous cash reserves, they probably aren't going extinct any time soon. But they also must find a way to make money in a rapidly changing field. The days of upgrading the chip or the operating system in your desktop computer are long gone.
But Microsoft is making inroads into mobile computing, as well as in transferring its software products from one-time purchases to ongoing subscriptions — a tactic that provides much steadier revenue streams. The company now has about 25% of the market in cloud computing.
In tech, it's never a sure bet, and there are more tech failures on Wall Street than there are old cables in your desk drawer. Whether Apple can continue to be a leader without Steve Jobs is an open question, for example. But it's probably best to bet on a company with a reasonable price and a good shot at a turnaround than on a company offering a great idea and little revenue. (We're looking at you, Twitter).
As always, it's safer to invest in a portfolio of tech stocks than it is in individual companies. Your tech fund may fall 50% — and that's always possible with tech — but it won't vaporize entirely, as Pets.com and dozens of others of dot-com companies did from 2000 through 2002. The five best tech funds for the past five years are in the chart.
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