Cashing in on TECH STOCKS - technology stock picks

Black Enterprise, March, 1999 by James A. Anderson

They may have tremendous potential, but how do you tell the difference between a sure thing and a pipe dream?

AUDRAY McMILLIAN HAS BECOME WIRED INTO TECH stocks. After watching share prices for myriad issues soar to phenomenal highs, he just couldn't resist expanding his holdings in these companies. "Tech shares offer some of the best opportunities around," he asserts. "You can only imagine that there are millions of e-mails sent every day, and that as popular as computers are, there still isn't one in every household or even classroom. To me that means the market for products like these has plenty of room to grow."

With the help of his financial planner, the 36-year-old Houston real estate developer has reprogrammed his $150,000 retirement portfolio by purchasing large positions in tech stocks, including such notables as Compaq (NYSE: CPQ), the manufacturer that posted gains of roughly 200%, and Cisco Systems (Nasdaq: CSCO), a computer networking company that grew 143% by late December.

McMillian is among the growing number of investors who are seeking to cash in on the technology boom. From companies that provide access to the Internet to manufacturers of laptop computers, this sector represents the greatest force propelling the stock market today. We get sweaty palms at the mere mention of such companies as America Online (NYSE: AOL) and Amazon.com (Nasdaq: AMZN). And with good reason. Last year alone, AOL produced a mind-boggling 361% gain while Amazon. com was up a staggering 900%.

But technology has proven to be the most volatile of sectors. On January 6, the Dow cracked the 9500 level as stocks surged 233.78 points--the seventh largest point gain ever. The charge was led by tech stocks. A week later, on January 13, the market dropped 125.12 points, due to the devaluation of Brazil's currency. Such hot internet-related stocks as Amazon.com, Broadcast.com and eBay dropped 8%, 14% and 26%, respectively in one week.

So just how in the world do you figure, out what makes these stocks move? To most of us, the talk of Internet protocols, software upgrades, wafer boards and next generations is enough to make us feel like Fred Flintstone hurled unceremoniously into the world of the Jetsons.

The simple fact is this: technology shares just aren't measured like other stocks. Many software, hardware, semiconductor or Net shares don't fit the neat understandable price-to-earnings (P/E) multiples that we've learned to use as a guide to making stock purchases. And shares aren't cheap: AOL has a stock price about 280 times earnings, at a time when the Standard & Poor's 500 fetches a P/E of only 20.

Investors are banking on future earnings growth and, as a result, have bid share prices to astronomical levels. But you can just as easily find sad tales of individuals who have bought a speculative issue and seen their investment evaporate at the first sign of crisis.

Still, the right mix of tech stocks will offer you highly charged returns. Even with the turbulence experienced in the market, the sector had a banner year in 1998. As of mid-December, in fact, the Pacific Stock Exchange Tech Index, the barometer for the technology sector, was up 40%, outpacing the 18% return for the S&P 500.

You can find-a way, however, to plug into tech stocks and produce maximum gain with minimal risk. BE suggests that you take a long-term view: Find those that have withstood the test of time as you create a sound investment portfolio.

MEASURING STICKS

We talked to a group of experts to let you know the best method to sniff out winners. First, you need to figure out how to value technology stocks. For most companies, you examine the earnings per share, the manner in which Wall Street divvies up a company's profits to shareholders. After assessing how quickly or slowly earnings are growing, you then compare the company with the broad market by looking at the PIE multiples--the share price divided by its earnings per share. To gauge whether the stock is indeed a bargain, you'd compare that figure with the P/E of the S&P 500 or Dow Jones Industrials.

Portfolio managers use the same yardstick for tech issues, but differently. Since investment pros have found that tech companies can grow earnings faster than retailers, financial services firms or industrial companies, their shares stand a greater chance of appreciating over time. Because of that ability to increase value, tech shares are allotted a higher multiple in the market.

A good example is Cisco Systems. Wall Street analysts believe that the computer networking company is slated to increase earnings at close to a 30% clip over the next five years, according to Zacks Investment Research. That figure significantly dwarfs the S&P's projected earnings growth rate of 7% over the same period. Since Cisco's shares will stay in high demand, the company's shares trade at a P/E of 75 instead of 22, the market average. Because of this factor, money managers tend to use P/E multiples to differentiate stocks in the same industry since they face similar competitive challenges.