Pulse: A Tougher Economy Means Tighter Value Standards for High-Tech Stocks

High-tech values and the prospect of lower interest rates faced off this week against the reality of constricting macroeconomics and information technology budgets.

Reality won and the Nasdaq Composite continued its shrinking routine.

"In a contracting environment your [value] standards become much tighter. In a loose environment, your standards become wide. This is a decelerating environment," said Scott Turkel, managing partner in TCM Partners.

Net/Tech Indices INDEX CHANGE % VALUE TSC Internet 28.25 -8.89% 289.46 TSC E-Commerce 1.08 -5.96% 17.04 TSC E-Finance 1.43 -4.57% 29.85 Nasdaq 159.18 -6.2% 2407.65

Despite the Fed's rate cut this week, persistent optimism on the Street and nearly 10 months of continuous correction, the values of many tech stocks still have an unrealistic ring to skeptics.

"I think that some of the best shorts in the tech area are some of the names with high visibility and have valuations that are still obscene," Turkel said.

It has become a given that IT budgets will contract next year, although predictions vary on how much. In a survey out this week of information executives, Merrill Lynch analyst Steve Milunovich estimated that IT budgets will grow an average of only 9% in the coming year, 5% in the U.S. and 13% in Europe.

Some of the executives' top-ranked spending priorities for the coming years were e-commerce and electronic data storage, two tech areas that have carried soaring valuations.

Some of those highflying e-commerce software companies that peaked at breathtakingly high prices in the past have now reached reasonable levels, Prudential Securities analyst Doug Crook suggested in a research note yesterday.

Using price-to-revenue as a measurement, Crook singled out Commerce One (CMRC Quote) as undervalued compared with other e-commerce stocks and with high-growth software companies. Crook said those companies peaked at 12 times revenue, while Commerce One, which had once traded at 50 times its estimated revenue, is now trading at five times. But his note still gave weight to growth over other measurements because he did not compare price to earnings , the traditional measurement of value, saying that margins of the high-growth software companies were still expanding. Commerce One ended the day down $3.38, or 15.4%, to $18.56.

Fellow e-commerce maker Ariba (ARBA Quote), which peaked at 90 times revenue, is now trading at about 12 times revenue, Crook wrote. Ariba closed off today $8, 81, or 20.5%, to $34.06. (Prudential Securities has no underwriting relationship with Commerce One or Ariba.)

In another traditionally high-value area, storage stocks still command a heavy premium, even over other big tech names.

A.G. Edwards analyst Shebly Serafi said storage companies, which produce devices and software for electronic data storage, command a premium even over those of established Internet structure stocks.

The storage stocks, EMC (EMC Quote), Emulex (EMLX Quote), Veritas (VRTS Quote), Network Appliance(NTAP Quote) and Brocade (BRCD Quote) have a price/earnings-to-growth ratio of about 1.77, he said, a full third above the average of shares of five of the biggest Internet infrastructure stocks, a group that includes Cisco (CSCO Quote) and Oracle (ORCL Quote).

EMC closed off today $6.31, or 8.9%, to $64.38. Emulex was down 11.3%, Veritas was off 12.4%, Network Appliance was down 17.7%, and Brocade was down 8%.

Is that premium for growth worth it? There is justification, said Serafyi. Storage stocks are seen as recession-resistant, "the last to fall and the first to recover," he said. Fundamentals are sound, too -- none of the major storage companies has issued an earnings warning, he said. And executives surveyed by Milunovich rank spending for storage among their top three expenditures for the coming year. (Serafyi's firm has no underwriting relationship with any of the stocks mentioned.)

"There is some justification for paying a premium," Serafyi said. "The question is, how much?"