Given the massive losses many investors suffered from 2000 to 2002, it is shocking to us how much blind faith investors place in large-cap technology companies like
, as if some pixie dust will help these companies return to the strong revenue and earnings growth they experienced in the 1990s.
Contrary to the opinion of many Wall Street strategists and analysts that big-cap tech is set to outperform, we believe big-cap technology companies will continue to struggle. We expect that the biggest moves will be made by smaller companies directly levered to growth trends happening today. Here's our case.
The Law of Large Numbers
Quite simply, even if we ignore market-share losses, does anyone really believe Intel can deliver much growth on its $40 billion revenue base?
Maturity is a dirty word when it comes to analyzing stocks. What causes technologies to spread? Falling prices, which in turn drives volume growth. But what happens when volume growth slows while prices continue to fall? A huge slowdown in growth.
The People Problem
There is zero solid evidence to suggest big companies are managed any better than small companies. In fact, we believe the bigger a company gets, the larger the number of ineffective people that the company is likely to employ. When you have 100 employees, it is easier to make sure you have the right people in place. In a small company, workers are more apt to be smart, aggressive and maniacally committed.
But what about a company with 10,000 people? Or 100,000 people? It is nearly impossible for a CEO to realize how many of the company's staff is smart, aggressive and truly dedicated to its cause.
The Index Effect
People who have a portfolio chock-full of tech stocks like the ones we've mentioned here need to ask themselves why they just don't own an exchange-traded fund like the
Nasdaq 100 Unit Trust
. After all, these companies basically dictate the moves of the index and returns aren't likely to differ very much.
So why not save the trouble and just stick with the ETF? A person could save time by not having to research each individual company, and would come out with similar returns in the end.
Plus, it takes a huge amount of new money coming into the market to produce a substantial, sustained rally in a widely-held company like IBM. With an uncertain economy and market outlook, we would not bet on this.
The Lack of Trend Concentration
, we tend to favor stocks that have high exposure to emerging trends, a characteristic absent in most big-cap tech stocks. On the other hand, small- and mid-cap companies are often highly leveraged to these growth opportunities that provide only a small benefit to a big company.
Take, for example,
model portfolio holding
, which makes software and hardware that allow companies to monitor employee Web activity and keep Internet connections secure. Because Internet connections are the obvious point of transmission for computer viruses and spyware, we wanted a company directly leveraged to protecting this invasion point, which brought us to Websense.
We can also look at the video-game world for an example. Take, for instance, retailer
, whose entire business is selling video games. On the other hand, Japanese electronics giant
makes not only the PlayStation and PSP, but is also involved with televisions, music and film. If a market participant is bullish on video games, it makes more sense to bet on a company like GameStop rather than Sony, which has numerous other businesses that could offset strength in the video-game sector.
Back to Reality
Ultimately, investors should focus on stocks' attributes rather than superficial descriptions such as "well managed" or "blue chip." If you're looking for a growth stock, make sure it's actually growing! How big is the addressable market? If you're analyzing a consumer tech stock, look at the company's products! Are they selling? Are they taking market share?
The mainstream media continue to harp about how small- and mid-caps have outperformed over the past five years and therefore large-caps should come back. While this scenario is quite possible, we are still certain that in technology the biggest moves will be made by smaller companies that are levered not to the economy and overall IT spending, but more to specific growth trends. As a whole, large-caps may outperform, but the best-performing individual equities will be small- and mid-caps.
When it comes to tech, Wall Street loves growth, and that growth will not be delivered by $100 billion giants with little leverage to emerging trends, which range from IT outsourcing to on-demand software to Internet Security. It will be delivered by the smaller companies that are devoting all of their time and resources to a specific growth market because their survival depends on it.
Michael Comeau is a research analyst at TheStreet.com. In this role he performs stock analysis for Action Alerts PLUS and Stocks Under $10. He is also a regular contributor to RealMoney.com. Prior to his arrival at TSC in June 2004, Comeau worked as a consultant to Toyota Motor North America, performing in-depth research on automotive industry issues, primarily in the areas of alternative engine technologies, competitive analysis and macroeconomics. His primary market interests include consumer technology, specialty retail, and small-caps. Comeau received a bachelor's degree in finance from Brooklyn College, and is a Level II candidate in the CFA Program. William J. Gabrielski is a research analyst at TheStreet.com. In this role, he works closely with Jim Cramer and conducts extensive stock research for Action Alerts PLUS. Prior to joining TheStreet.com, Gabrielski worked in the equity research departments of Individual Investor Group and First Montauk Securities. He also worked at Rumson Capital on their databases and models. Gabrielski, a graduate of Monmouth University with a degree in economics, is accredited with a Series 7 license.