Technology Stocks May Waiver, But Only Briefly
On July 12, Charles A. Morris, the young manager of the T. Rowe Price Science and Technology fund, sent an unusual letter to shareholders, reminding them that “during these times of extraordinary returns, it is easy to overlook the risks that accompany such substantial rewards.”
The timing of his warning, which the firm called “a cautionary letter,” was impeccable. High-technology stocks had been soaring, but on July 17 and 18 - immediately after most investors found the missive in their mail - Morris’s fund lost 6.3 percent of its value. On Wednesday, the top holding, Xilinx Inc. was down more than 11 points from its all-time high, reached the previous day.
Xilinx is a supplier of field programmable gate arrays and CMOS programmable logic devices.
The Morris letter provides two lessons:
T. Rowe Price Associates Inc. is one classy outfit. Not many companies have the integrity to warn customers that they may be overly enthusiastic about a product.
The technology sector is an overripe fruit, ready to fall from the tree.
For the 12 months ending June 30, the Price fund returned 68 percent, drawing investors like, well, like an overripe peach draws flies. Assets tripled, to $1.8 billion.
Actually, T. Rowe Price Science and Technology looks downright conservative compared with other high-tech funds. Seligman Communications and Information has produced returns of more than 100 percent over the past 12 months, and Fidelity Select Electronics is up 61 percent in the first half of the year alone.
But Morris was admonitory: “Science and technology stocks can be a “hang-on-to-your-hat’ kind of investment. Periods of strong advances are often interrupted by declines, sometimes abrupt and steep, which can sorely try an investor’s patience. We cannot predict what may touch off the next pullback, how severe it might be or even when it might occur. However, this industry sector has experienced declines of 10 percent or more every year since 1986.”
Look at Xilinx itself.
Last year, its price fell 50 percent in four months - with half of that decline occurring in just two weeks. Then, within another four months, it doubled; eight months later, it doubled again.
There’s no doubt high-technology stocks will grow the most in the next decade. Authors George Gilder and Esther Dyson make convincing arguments that we’ve only begun to experience the power of the microchip and that it will change the world profoundly by making nearly everything cheaper to produce.
But the arcane terminology - “field programmable gate arrays” - is mind-boggling, and a good rule for investing is never to buy companies whose line of work you can’t explain to a child. The reason is simple: If you don’t understand a company, then you don’t know why you bought it and you can’t tell when to sell it.
As a result, you’re usually better off buying high-tech stocks through mutual funds - either specialized funds such as Price Science and Technology or more general funds whose managers lean to high tech from time to time. The best recent example is Fidelity Magellan, the world’s largest fund, which has 40 percent of its assets in tech stocks, up from just 13 percent in 1993.
High-tech stocks (and the funds that own them) offer dangers that more pedestrian stocks lack, the main one being “earnings disappointments.” This means that profits have to meet the expectations of analysts - or else.
For example, Intel Corp., the world’s largest semiconductor maker, recently reported quarterly earnings of $879 million, up 37 percent over last year. But that wasn’t good enough. The average analyst had predicted a 42 percent rise. So Intel stock fell more than 11 points, or 14 percent, in two days, dragging lots of smaller companies down with it.
Other stocks rise and fall on analysts’ expectations, too, but high-tech shares are particularly vulnerable - partly because they’re so hard to predict and partly because they tend to trade at lofty multiples of earnings since the market assumes they’ll keep growing at a rapid clip.
For example, two weeks ago, the price of Microsoft Corp. stock was 44 times the company’s earnings per share. That’s a P/E of 44, compared with 16 for General Electric Co., a steady profitmaker.
With high-tech stocks, a wild ride is almost guaranteed. But if you hold on, you’ll probably make more money than you would through tamer pursuits.
Over the past five years, high-tech funds have returned an average of 21 percent annually while general equity funds returned 12 percent, according to Lipper Analytical Services Inc. Over 10 years, the differences were narrower but still very significant: 17 percent for tech, 13 percent for general. An investment that produces a 17 percent compounded return will double every 4-1/2 years.
While this seems a poor time to buy high-tech stocks, you may be making a mistake if you sell your current holdings. Technology is the classic buy-and-hold investment. You should purchase shares because of faith in companies, managers and the progressive nature of science. Believe, and stay cool. Short-term trading in such stocks is a recipe for disaster.
But are there any good tech buys out there? Eugene Peroni of Janney Montgomery Scott Inc. in Philadelphia, who has a superb track record, likes Cabletron Systems Inc. Ed Welles, a value hunter who publishes an erudite newsletter called Common Stocks, Common Sense in Concord, Mass., recommends Microtouch Systems Inc. Analysts at Smith Barney Inc. just gave a top rating to GMIS Inc., which provides information systems for health maintenance organizations and government entitlement programs - a growth industry.
Value Line Investment Survey lists Cirrus Logic Inc., FIserv Inc. and Gerber Scientific Inc. among its 100 most timely stocks.