Where's the Tech Sector Headed? Up, Say These Fund Skippers

The ailing technology sector is due for a checkup -- especially since some folks think it's due for a recovery. While many fund managers continue to avoid the tech wreck as best they can, some intrepid, not to mention optimistic, managers have begun upping their tech stakes considerably.

What they're buying runs the gamut. Some are excited by particular sectors, while others are looking for specifics on the balance sheet. Still others are seeking out either high-growth small-caps or undervalued large-caps. Clearly, there's little consensus on where the bargains are or which companies will lead the recovery.

To get a sense of where tech stocks may be heading, we solicited the insights of four members of the "smart money" set -- including a few who were burned in the tech wreck of the past few years. Some of their answers may surprise you. Read on, if you dare.

Jim Norris: Patience

Timing is tough: The same managers who failed to call the top of the market (an admittedly impossible task) are equally unable to spot sure signs of a turnaround. But value managers like Jim Norris are patient people, usually willing to hold onto shares through a couple of bad quarters while waiting for the upswing.

"We choose stocks with an outlook that goes beyond six to 12 months," says Norris, co-manager of (CBMDX)Cooke & Bieler's Mid-Cap Value fund. "Typically, most stocks we buy have a short-term temporary issue. We're not afraid to live through a few bad quarters."

The bubble's deflation wasn't a short-term temporary issue, though -- at least, not according to Norris. "A lot of people thought that just because tech was down 60% they're automatically value stocks," he says. "Value stocks are quality companies that have a problem. A lot of the tech companies that got hit hardest early were not quality."

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About six months ago, though, Norris began buying more technology companies, and now has 13% of fund assets in technology -- almost double the 7% technology weighting of the Russell Mid-Cap Value Index. He looks for companies with no debt, considerable cash flows and a competitive advantage. One of his most important metrics is debt to total capital -- the average company in his portfolio has 28% debt to capital, whereas the average of the Russell Mid-Cap Value index is 41%.

Also, Norris keeps the interest coverage ratio -- a measure of how much cash a company generates relative to its interest payments -- higher than the index. The median interest coverage ratio of companies in his portfolio is 10, meaning the companies generate 10 times their interest expenses in cash. The median for the index is just five.

With such stringent balance-sheet requirements, Norris isn't afraid to venture into some of the most maligned subsectors of technology. One favorite company is ADC Telecom (ADCT), which supplies equipment to regional bells. ADC dominates the market, sharing just a portion of it with a private company. "We're early on this," Norris acknowledges, "but in five to 10 years, ADC will still be around." Norris' fund holds stocks an average of three years.

Another dominant market player Norris likes is Dionex (DNEX), which owns 85% of the market for ion chromatography equipment. The company makes equipment that tests for impurities in liquid. Applications range from testing municipal water systems to quality control of pharmaceuticals. This zero-debt company has positive free cash flow after investing considerably in itself (including buying back shares), and a guaranteed revenue stream from not only the sale of its equipment, but also from the cartridges that need regular replacement.

Mark Schultz: Follow the Leaders

There are several areas that Mark Schultz, manager of the (GVEGX)Vision Large-Cap Core fund, is wary of, though he's inclined to single out the leaders he thinks will be the first to come out of the downturn.

Schultz recently upped his fund's stake in technology to 17% -- the maximum the fund's bylaws will allow. Instead of buying more companies, though, Schultz has taken larger positions in the leaders he favors, such as Dell(DELL), Texas Instruments(TXN) and IBM(IBM).

"We're staying away from wireless -- the finances are too bad for all the companies in that food chain," Schultz says. "And we're very cautious on computers and peripherals. Demand is just not sufficient to support people's expectations from those companies." That didn't stop him from doubling his stake in Dell in the spring.

When demand finally picks up, Schultz reasons, businesses will turn to the established leaders in each field. "Companies are going to be reluctant to go out and experiment with new technology or new companies," he says.

"I'll stick with the companies I have confidence in; there's plenty of good performance to be found in picking leaders," Schultz says. "This is not the time to be heroic."

Kevin Landis: Big Money in Big Brother

Security is most often cited as the technology subsector that will ramp up soonest. That's where Kevin Landis, manager of the (TVFQX)Firsthand Tech Value fund, has found his most interesting ideas of late. Landis has shifted assets away from general information technology-oriented companies towards those able to capitalize on the government's growing need for better security systems.

"We have a huge government with massive silos of information that are incompatible," Landis says. Companies like PEC Solutions(PECS), which offer IT consulting to a variety of government agencies, are perfectly poised to capitalize on the emphasis on "homeland security."

Another Landis favorite is FLIR Systems(FLIR), the leader in thermal imaging and stabilized camera systems. (FLIR is from "forward looking infrared.") FLIR's technology can, for instance, scan a parking lot and determine which cars have just parked based on the heat given off. "There are great opportunities for this technology," Landis says.

For more on Landis and his fund shop, check out Firsthand Smoke? Landis Explains Retrenchment.

Bob Turner: Waiting for the Upturn

Long-time tech optimist Bob Turner of Turner Investment Partners sees opportunity throughout the sector. "If we've learned anything in this downturn, it's that technology is cyclical like consumer durables or other industries," he says. "And after two years, we're getting reasonably close to an upturn." Turner's (TTOPX)Concentrated Growth fund is edging past 50% of its assets in technology.

Inventories -- the bane of the bust -- are finally at their lowest in 20 years, Turner says. That means that as soon as companies and consumers increase their spending, the suppliers will begin an upward cycle. And while Turner concedes it may still be early to anticipate any quick gains, he says the upside potential more than mitigates the downside risk.

He illustrates his approach with Cisco Systems(CSCO). Cisco, which has an 80% market share in an industry growing 10% to 15% a year, trades at $12 a share, and has gone as low as $11 in the last year. "Now, Cisco could go back to $11.50 or so in the near term, but that's just a 5% to 7% downside," Turner says. According to his conservative valuation, though, Cisco should soon be trading at $15 to $16 per share. Buying now means risking in the short term $1 per share, with the expectation that it will actually rise at least $3 a share in the not-too-distant future. "That's a 3-to-1 upside," he says. "I like that risk/reward profile."

Leaders such as Microsoft(MSFT) and EMC(EMC) have that same profile and are just as attractive, Turner says. While such behemoths will likely benefit soonest from a recovery in the sector, Turner is just as interested in smaller, high-growth companies, particularly in the storage space.

Companies like Brocade(BRCD), Q-Logic(QLGC) and Network Appliances(NTAP) will have more momentum once a recovery is underway, he says.

"When the market goes up, people will certainly gravitate towards giants like Intel(INTC), Microsoft, IBM and EMC," Turner says. "But many smaller companies -- such as some storage and security firms -- are growing faster and will be better looking. It won't be long before investors go there as well."

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