RealMoney Silver - Tech's Too Hot? Says Who?

Tech's Too Hot? Says Who?
By Michael Comeau
Research Analyst
10/30/2007 1:34 PM EDT

One of the hottest topics of debate in this stubbornly strong market for tech stocks has been the idea that leadership in the sector is narrowing. Just this weekend, Barron's permabear Alan Abelson quoted some stats our buddy Doug Kass had recently discussed on the index, saying that "roughly 25%, or nearly 450 points, gained by the Nasdaq 100, a whopping 230 points, or over half the index's rise, has come from just three issues: Apple (AAPL) (135 points), Research In Motion (RIMM) (60 points) and Google (GOOG) (35 points)." It's time to examine whether these numbers are really meaningful and see just how overheated tech is.

First things first, I'm going to point out some basic facts about the Nasdaq 100 that nobody seems to care about.

The Nasdaq 100 is a market-cap-weighted index with just 100 stocks, so of course the largest companies are going to have a disproportionate influence on its overall performance. Plus, the Nasdaq 100 contains plenty of nontechnology stocks, like infrastructure play Foster Wheeler (FWLT) , food retailer Whole Foods (WFMI) and casino company Wynn Resorts (WYNN) , not to mention a whole bunch of biotechs like Gilead (GILD) .

Finally, let's not forget that there are plenty of tech stocks trading on the NYSE, like IBM (IBM) and EMC (EMC) . So overall, the Nasdaq 100 is not the best indicator of tech-stock performance. And while the 25% year-to-date return on the Nasdaq 100 gets a lot of attention, the more appropriate Morgan Stanley Technology Index is up 18%.

Nonetheless, using the ever-handy Capital IQ, I decided to take a deeper look at data on Nasdaq 100 stocks to see what the headlines may be missing. Just a couple of warnings -- I am data-mining here, and as Homer Simpson once said, "People can come up with statistics to prove anything. Fourteen percent of eople know that!" Plus while Capital IQ is excellent, no financial database is perfect, so if you try to replicate my efforts with a different product like Factset or Bloomberg, you may get slightly different results. And finally, the Breakout Stocks newsletter is heavily weighted in what I regard as high-quality tech growth stocks.

Anyway, looking at data on the Nasdaq 100, leadership doesn't look narrow at all. In fact, as of Monday's close, the average stock in the index is up 21% for the year, with 71 of the 100 stocks in positive territory, and 31 of them being up more than 25%.

And looking closer at the tech names in the Nasdaq 100, stocks in the information technology and telecommunication industries were up 18%, which is the same as the year-to-date return on the aforementioned Morgan Stanley Technology Index. That's a nice relative return compared to the S&P 500 this year, but not the mark of a truly overheated sector.

Moving forward, let's take a look at deeper tech-stock performance beyond the Nasdaq 100, using the following parameters:

NYSE or Nasdaq as primary exchange;
information technology or telecommunication services as primary industry; and
market cap over $1 billion to start the year.

I came up with 278 names. Here are my conclusions:

If you focus on more than the Nasdaq 100, tech actually hasn't been all that hot this year, with the average name up 14%. The mega-cap stocks that have been moving the index the most have been reporting very strong quarterly earnings numbers, so it makes sense that the Nasdaq 100 is up so much.

So, the lessons here? First, don't place too much emphasis on the returns shown by market-cap-weighted indices. After all, are your returns market-cap-weighted? Second, tech is not a monolith, and tech stocks are not being rewarded across the board. The top tech performers this year, like Baidu.com (BIDU) , Research In Motion, Apple, and Google have been reporting excellent quarterly numbers and enormous earnings growth, qualities investors are willing to pay up for.

Looking at the worst tech performers, you have names like Isilon Systems (ISLN) , Vonage (VG) and Level Three Communications (LVLT) -- companies that haven't been performing all that well from a fundamental standpoint, showing that investors don't seem willing to pay up for lower-quality companies.

In conclusion, I don't think that tech is overheated at all. The big return of the Nasdaq 100 makes for good headlines, but plenty of tech companies have been left behind. There's no doubt that stocks like Research In Motion and Baidu look a bit frothy, but they looked that way when they were 50% lower, and they have huge long-term growth opportunities.

If you're looking for tech stocks today, focus on the companies that have been putting up strong numbers, have strong balance sheets and have a secular or cyclical growth component. One you might want to look at is Breakout Stocks pick Netgear (NTGR) .