NEW YORK (
) -- Technology stocks have been soaring, and mutual funds that invest in them have returned 73% in the past year, outpacing the
S&P 500 Index
by 40 percentage points and ranking as the top-performing domestic fund category, according to Morningstar.
Now the outlook for the sector remains positive. The recession hurt sales in 2008, but in recent months, demand for some consumer products, such as smart phones, has been growing sharply. Corporate sales are improving.
The healthy picture represents a big turnaround from the bleak days earlier in the decade when the dot.com bubble burst. During the hard times, the picture for technology stocks resembled the outlook faced by financial shares in the depths of the credit crisis this year. As investors began dumping Internet stocks in 2000, many high-flyers disappeared, and investors worried that even blue chips were about to go under.
Share prices fell for years. The forward price-to-earnings ratios on technology stocks dropped from a high of 36 in 1999 to 12 in 2008, according to
T. Rowe Price
. But while technology stocks languished, the fundamental performance of the businesses steadily improved. From 2003 through 2007, many companies reported annual revenue gains of more than 10%. Operating margins for the industry remained at double-digit levels. Troubled by memories of the dot.com crash, many companies stockpiled cash and improved their balance sheets.
With the industry on firmer footing, should you consider buying a technology fund? It depends on how much technology you already have. If your portfolio resembles the S&P 500, you have 20% of your assets in technology and telecommunications. That may be enough for cautious investors. But for those who can tolerate some risk, there is a strong case for buying a technology fund and overweighting the sector.
While the overall economy has tended to grow at a 3% annual rate, the long-term growth rate for technology is 5%. Technology is likely to continue enjoying strong demand as companies seek ways to increase productivity and consumers spend a bigger share of their budgets on computers and cell phones.
Make no mistake, technology can be volatile. During the three years ending in February 2003, technology funds lost 79% of their value. But as investors discovered this year, technology can score outsized gains when the market rallies.
To invest in a relatively mild-mannered fund, consider
BlackRock Science & Technology
, which has returned 5.4% annually during the past five years, outdoing 80% of its competitors and surpassing the S&P 500 by 5 percentage points. The managers look for reasonably priced stocks that seem poised to deliver unexpected growth.
The BlackRock portfolio is dominated by blue chips. A sizable holding is
International Business Machines
. Earnings have been growing at double-digit rates, but the stock sells for a price-to-earnings ratio of only 13. "IBM will continue to grow as technology spending increases around the globe," manager Jean Rosenbaum says.
Another holding is
. The company recently reported higher earnings because of cost cutting. Rosenbaum says earnings can continue climbing as the company goes through more belt-tightening.
To take on a bit more risk, consider
, which has returned 5.1% annually during the past five years. Early in the year, manager Telis Bertsekas scooped up some unloved cyclical stocks that sold at bargain prices. Now that the cheapest stocks have rebounded, he's emphasizing companies that can show strong long-term growth. A favorite holding is
. He says the company has about 5% of the world market for personal computers. In coming years that figure is likely to double, he says. "Apple's earnings should increase at a 15% rate for many years," Bertsekas says.
Bertsekas also favors
. He says the company will continue to benefit from the growth of online advertising.
Another solid fund is
T. Rowe Price Science & Technology
, which has returned 2.2% annually during the past five years. Manager Ken Allen holds a mix of strong growth stocks and unloved value plays.
A growth holding is
, which supplies software for Linux open-source operating systems. Allen says the business is stable because customers purchase subscriptions and regularly renew them. "The business has grown at rates in the mid teens -- even during times when overall tech spending was declining," Allen says.
An unloved holding is
, which supplies software used to manage and monitor IBM mainframe computers. Allen says the business is reliable. "Their software is very important to customers, and it would be expensive to replace it," he says.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.