Top techs in a skeptical market
A small-cap fund manager highlights some favorite innovators in the technology sector.
When I started in the investment business in 1995, it was an exciting time in technology. It was the eve of the dot com revolution.
The wave of innovation that followed ranked among the greatest in human history, birthing companies like Google (GOOG), Amazon (AMZN), Facebook, eBay (EBAY), and YouTube (and surely many more will follow). Here, we look at the current state of the tech sector, as well as our favorite stocks.
As exciting as this period was, tech stock valuations trumped reality by a mile, with stock prices eclipsing levels in the late 1990s that even optimists declared absurd. We all know the unfortunate hangover that followed.
Now, after 2008s disastrous stock market decline, the technology pendulum had clearly hit the opposite end of the spectrum, moving from pervasive optimism eight years earlier to persistent skepticism.
By 2008, stock prices were determined by present cash flows, with little premium associated with a pipeline of innovation.
But times always change. Technology has performed well again since 2008, and some sectors, like social media firms, are likely already frothy. Social media valuations for companies like Facebook seem reminiscent of 1999.
Even though they look incredibly expensive today, a few will grow explosively and monetize their users enough to emerge successfully, like Google and Amazon. But most will not live up to the hype (or valuations).
And as all dot com alums know well, telling the difference between those that will succeed and those that will fail is a tough game to play at the onset, especially when most are already being valued as winners in the stock market. Winning as an investor is certainly not guaranteed.
That said, outside of social media, the prospects for high-growth technology stocks appear to be among the most attractive of my 17-year career. Valuations are cheap and growth appears to be accelerating.
Our favorite ideas fall primarily into three categories: 1) smartphones and data traffic enablers; 2) "Uncle Scrooge" facilitators; and 3) bottleneck innovators.
Riding the smartphone wave, take a look at Ceva (CEVA), Cirrus Logic (CRUS) and NetQin Mobile (NQ). To profit from the exponential increase in broadband data, we recommend Acme Packet (APKT).
For Uncle Scrooge facilitators, look for companies that save money for their users, generating a measurable return on investment.
Kenexa (KNXA) helps companies save money in recruiting. Web.com Group (WWWW) helps small businesses save money on their website setups.
Our bottleneck innovators improve speed and efficiency. For example, take Mellanox Technologies (MLNX), which is a fabless semiconductor company that makes high performance products that connect servers with other servers and storage devices.
Their Infiniband technology costs more but it is much faster than Ethernet. As Intel (INTC) moves to its new Romley and Sandy Bridge architectures, that speed advantage clears a bottleneck in the data center. Data centers will eagerly pay for bottleneck innovators.
Technology stock valuations have fallen a long way since 1999. It was a bitter ride down, one that most of us would hate to repeat. Still, a compelling argument can be made that now is the time to take the risk.
Though not as cheap as in 2008, technology valuations outside of social media appear very reasonable.
With the economy finally moving in the right direction, reasonable valuations, and a strong wave of innovation tied to mobile devices, now is the time to load up on technology.
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