Don’t Miss the Tech Stock Revival

The economy will always have its booms and busts–and the same goes for financial markets. But the advance of technological innovation is constant. That’s Richard Shaw’s core belief, a principle that guides his research into technology and telecommunications investments as senior vice president and equities analyst at Bessemer Trust in New York City.

Shaw began his career in the mid-1990s, just as investors were pumping a lot of hot air (and money) into the dot-com bubble. More than a decade later, some investors are still shy when it comes to buying shares in technology companies. However, Shaw says, “Going forward, the tech sector will have better growth, stronger balance sheets to do major acquisitions, and better strategic focus than many other industries.” Shaw talked to Black Enterprise about companies that are positioned to prosper in the Internet’s latest voice, data, and video revolution.

What tactics should investors employ in 2010? Does a long-term, buy-and-hold philosophy still work?
Yes, but investors have to be aware. There will be selective areas in the markets where you’ll be able to have greater-than-average growth. We’re in an environment where stock picking will be more and more important. I completely believe in the buy-and-hold strategy. Having the right asset allocation and diversifying your portfolio are key.

What’s the overall philosophy that guides your investment decisions?
The philosophy here is a “normalized framework.” We’re looking at gross and or operating margins to see if companies are over-earning or under-earning when weighed against their historical margins. If margins are off, we ask whether it’s because of a competitive issue, because of recession, or something beyond the company’s control. The kinds of themes I like to look for are companies that are secular growers; cyclical companies [whose revenues tend to increase when economies are on the upswing]; companies that will see improvements in business due to internal restructuring, or government regulation; and those that have internal businesses that are worth more as spin outs or are being unlocked for value. I look at the company’s competitive positioning and their strategy. That’s the framework of how I go about looking at stocks.

When you apply that framework, what are some companies that you like right now?
One of them is EMC Corp. (EMC), a leader in the storage space. They are a provider of networked information storage systems for large enterprises. The investment premise for EMC is that the company is under-earning versus its historical earnings. Their operating margins have historically averaged around 13%. They are currently doing about 9%. That’s because of a contraction in IT spending, which went negative in 2009 in terms of growth. As IT spending recovers, storage, which is a category within IT spending, will see a

faster growth rate. I believe EMC will recover their operating margins to the level of 13%. Within the category, they’re still a leader in the market they compete in. The other thing I like about them is that they’ve consistently generated positive free cash flow, which is good for sustainability, making acquisitions, and buying back shares. EMC recently bought for cash Data Domain Inc., paying $34 a share in cash. Data Domain specializes in data de-duplication, a technology that prevents duplication of files being stored on networks and storage devices. It reduces the storage capacity that companies need when backing up data. And it’s a key functionality to enhance EMC’s product offerings. That business combined with EMC’s existing business in data duplication should be able to generate $1 billion in revenues by the end of 2010. EMC also has a really great balance sheet. My 12-to-18-month target price for EMC is $25.

Tech stocks can be very tangible for investors because they can see how some products make people or companies more productive. Any other picks along those lines?
Research In Motion (RIM), is the maker of the BlackBerry smartphone. This is a somewhat controversial choice. Some investors believe that, as the company goes up against Apple’s iPhone, their pricing and margins will start to fall at a faster rate, which will cause revenue growth to

amp-ad-wrapper amp_ad_1 ampforwp-incontent-custom-banner ampforwp-incontent-ad3"> fall faster than expected. But the whole smartphone market is expected to grow by 35% in 2009 and by 42% in 2010. RIM is the No. 2 player in the market. RIM is still interesting–even with its recent earnings disappointments. The mix of products they sell is shifting toward consumers as opposed to corporate clients. Some 80% of new users are individual consumers. If you go back three or four years ago, that number was around 25%. RIM realized that there was incremental growth in the consumer market. You can see the company growing its net income in 2010. The competitive issue that many investors are concerned about is rising competition from the iPhone and the Palm Pre, which is being launched by Verizon soon. RIM is in a competitive market, but I don’t believe their market share is going to fall apart. BlackBerry unit sales in the last two quarters have been growing at a greater rate than overall industry growth. Even if you believe that RIM will grow at the pace of the market overall, you still get 35% increases in the number of units sold and revenue growth of about 30%. As a result, my 18-month target price for the stock is $100.

That’s an edgy choice. Do you have anything that’s a little less risky?
There’s Cisco (CSCO), which I believe will be a beneficiary of the economic recovery and rebound in information technology spending and telecom carrier spending. Cisco is the largest provider of routers and switches to enterprises and large telecom carriers. They have four different businesses: routers, which are 17% of revenues; switches, about 30% of their sales; services business, which is 20% of sales; and advanced technologies, which make up 25% of sales. They also own Linksys and a services business. They are at the core of the technology revolution that’s still occurring. They will benefit from an increase in telecom carriers and enterprises spending on their networks, especially to accommodate more activity, more video, more video conferencing, even Twitter. It’s an economic recovery story. As video and entertainment delivery increases online, it forces carriers and enterprises to buy new routers and switches to allow more capacity for the additional data. Cisco also has one of the best management teams out there. They make strategically sound acquisitions to gain a foothold in new adjacent markets. They’re also focused on the consumer market, where they hope to have a presence in the home, as consumers create media hubs in living rooms. If you believe in more data over the Internet, Cisco is the play on that. My 18-month target price for Cisco is $30.

This article orignally appeared in the December 2009 issue of Black Enterprise.