Editor's note: Robert Marcin's commentary also appears regularly on
To sign up for
where you can read more, please click here for a free trial.
As most readers know, I pursue a deep value investment philosophy and process. Like most value investors, I prefer stocks that have declined significantly to low valuations. But unlike many of my competitors, I'm very comfortable owning technology stocks as well as shorting them. Right now, I am net short technology. Here's why.
First, most technology shares have already experienced major moves from last fall's bottom. While the cap-weighted
is up north of 50% in the past nine months, many tech stocks have doubled or tripled in the same time frame. I rarely purchase stocks right after existing owners have made a killing. I leave that for momentum investors and chartists.
Second, most technology shares have become expensive -- even exorbitant. According to Steve Leuthold, of the firm that bears his name, the median price-to-earnings ratio of the largest 20 tech stocks is 44. Now, I know the tech bulls will claim foul. I'm using depressed profits, they'd argue. But when Leuthold "normalizes" earnings for the same group of companies, he calculates a P/E of 38. Some bargain!
Perhaps a better way to value tech stocks is through their price-to-sales ratios. Sales are much more stable than earnings, which have a way of disappearing in down cycles. Leuthold calculates a median P/S ratio of 5.3 -- more than double this group's 10-year historical median valuation of 2.56. These P/S ratios are closer to sector peaks (excluding the bubble), and they discount significant improvements in sales and profits for most tech shares. Again, not a great deal for your money.
Where's the Boom?
With valuations quite high, you might assume the sector is banging out tremendous gains in revenue and earnings. Wrong. Organic sales growth for many large technology companies is in the low- to mid-single digits. Check out the revenue numbers for bellwethers such as
. These businesses cannot generate double-digit sales gains even with huge currency benefits. Yeah, I know they all beat revised earnings estimates by a penny or two. Big deal. At some point, investors will figure out this game.
My final reason has to do with the owners of technology stocks, the OPMers, as I call them. (That stands for Other People's Money.) These are institutional and mutual fund investors who heave around the big dough -- hundreds of billions of dollars. These investors chase benchmarks and have bought tech simply because it has rallied. They're not the New Era Bubbleheads, true believers who presumed that tech stocks would grow 25% forever. At least those investors had exceptional growth rates to plug into their discount models to justify gaudy tech-stock valuations.
Today's technology investors need to acknowledge the existence of a more difficult world. For all except the chosen few, technology is a highly competitive, very cyclical, overcapitalized business with declining secular revenue growth rates. In total, the global information technology industry is probably not even a 10% grower. There, I said it:
. The sell-side analysts, always the last to get it, will spend the next few years slashing secular growth rates from the nonsensical 15% to 20% rates of the past to more sustainable levels in the high-single-digits. Stocks rarely act well as this occurs.
Heads in the Sand
Still, investors are choosing to ignore this new reality. They comfort themselves with the hope that a new technology upcycle is imminent. They justify high valuations with dreams of a huge replacement-demand recovery and exploding levels of profitability. My research suggests this is a pipe dream. But even if a tech boom is right around the corner, most stocks have already factored this into current price levels. That's the concept of discounting.
Although this is always dangerous to say, the next tech cycle will be different. When the tech business finally recovers, investors will sell the recovery profits earlier and more cheaply than ever before. Having experienced the wickedest downturn in technology industry history, investors will treat the stocks more like the risky investments they are. Except for the "category killers" such as
, Cisco and Applied Materials, technology stocks will probably be valued more like cyclical business than growth stocks. As a value investor who is well acquainted with deeply cyclical, slow-growth companies, I'm not surprised at the market's tendency to discount peak profits prematurely. But many technology investors will be.
Readers of my column understand I'm not a member of the technology perma-bear camp. In the mid-1990s, I invested virtually my entire portfolio in technology. And, as recently as last year, tech represented 40% of my holdings. Small-cap tech stocks represented excellent value in the panic of last fall.
The New Tech Mindset
The investor psychology is markedly different today. It embraces risk more aggressively than it shunned it last fall. Cheap to reasonably priced tech shares have given way to Internet "10-baggers" and concept stocks. Semiconductor and capital equipment shares trade for 50 times recovery earnings. No growth software companies trade for big premiums. Attractive tech specs have become candidates for tech wrecks if the sector recovery fails to materialize once again in this year's second half.
I still own partial positions in two stocks I've said I liked,
. But I've sold all others, from mega-cap
. I've shorted the
, as well as
I expect to short more semiconductor, hardware and telecom stocks should the market break further. The Nasdaq experienced a sharp pullback last week, which surprised the beta buyers and performance chasers. Many tech investors are not believers, but are simply along for the ride. What happens to these weak holders if the ride gets bumpy? My guess is that they'll bail. And it's a very long way down until these stocks reach the level of cheap.
Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin was long Artesyn Tech and MRV Communications and short QQQ, Amazon and KLA-Tencor, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to