James Morrow Talks Tech

The manager of the Fidelity Select Technology fund says the 'killer app' is overrated.
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Tech stocks are hot again. Valuations are getting stretched. People are looking for the next killer app.

Wait a second, haven't we seen this movie before?

The characters may be the same, but today's tech story is entirely different from the one that ended in ashes five years ago, says James Morrow, portfolio manager for the $1.8 billion

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Fidelity Select Technology fund.

Morrow says the tech industry is far more mature nowadays and won't revert to the mania of the previous run-up, even if the next app is truly a killer. Morrow's fund is up 4% this year and has returned 17% annually over the past three. Of course, go back another two years and the annual returns swing to minus 16%, but that was a different time. Maybe even a different universe.

Back in the here and now,


checked in with Morrow to get his opinion on the new environment for tech stocks and whether they can keep up the solid performance in the second half.

Jim Cramer has been pounding the table on technology lately, saying it's the place to be in the second half. Do you agree?

There is certainly a lot of momentum within parts of technology heading into the second half. From my perspective as a fund manager, there are certainly a lot of sectors and names inside of technology to be excited about. Maybe not as excited as Jim Cramer gets, but still excited.

Has the second half run-up already been discounted by the market?

Figuring out what's embedded in stocks is always the hardest question to answer, but I don't think there is a boom embedded. You still have tech stocks trading at valuations that are just modestly ahead of the broad market despite better growth. So it does not feel to me like valuations are stretched across technology today.

If you want to talk about stretched valuations, we can talk about the Internet. How do you handicap the big three: Google (GOOG) - Get Report, Yahoo! (YHOO) and eBay (EBAY) - Get Report?

There's two stories on the Internet, e-commerce and the advertising model. Let's talk about eBay first. eBay has one of the most dominant brands on the Internet and is clearly the leader in e-commerce globally. The stock had a hiccup in the first quarter, which created a buying opportunity for us.

You can't recreate any of these three brands on the Internet again. Only one major brand has been created in the last 10 years and that's Google. All the others started more than 10 years ago. They've been around a long time now, so it's hard to create the beachfront property that these three companies have.

This is a market starving for growth. The growth rates here are a lot higher than they are in other parts of the market. It gets to be this delicate game of "how high can we push the multiple?"

What about search?

The big-picture commentary on search is measuring the percentage of time spent vs. the percentage of available ad dollars. It still seems as though a lot of ad money needs to convert to the Internet. Anecdotally, we talk to a lot of different companies who say they are moving ad dollars away from traditional media and online. In fact, they say they are getting better payback online. My sense is that we are in the early innings, not the late innings for these business models.

And again, you can't recreate what Google and Yahoo! have in terms of mindshare. They are also dominant globally too, not just the U.S.

Which is stronger now: hardware or software?

From my point of view, the broader secular themes tend to be concentrated on hardware as opposed to software right now. If you look at the first half of the year, you've had largely hardware-driven momentum in terms of stocks. One way we have been playing that is through buying the component makers that supply the major hardware names. Namely semiconductor stocks as a way to get leverage on top of pretty attractive hardware cycles.

There are some broad hardware cycles out there. There are a lot of consumer electronics cycles going on. The video game console and digital television cycles, for example, are ramping. Digital music player and PC growth continues as well.

What about software?

The big software cycle that everybody is waiting for is Longhorn, which is still 18 months out in terms of real impact. That's almost forever in technology.

Speaking of Longhorn, or Vista as they now call it, what's your opinion of Microsoft (MSFT) - Get Report?

It's a stock that has grown earnings pretty nicely the past few years and the multiple has contracted accordingly. So it really hasn't been a great place to be. That said, the game-console cycle is coming their way. They are going to be first to market with Xbox and you do have Vista on the way. So there are more reasons to be interested in Microsoft going forward than historically. It's a name that's in the top ten holdings of the fund.

If you like hardware component stocks, give me your opinion on the chipmakers?

You had a robust year for semis in the aggregate in 2004, but the stocks performed quite poorly because it wasn't as good a year as people expected. It gets back to the hardware cycles. You had a classic "V" bottom pattern in terms of semiconductor consumption was going to have to catch back up to the end consumption in hardware. You are starting to see that play out now.

As a result, if you look at the five broad sectors of technology -- semis, software, hardware, services and cap equipment -- you will see that semis have been the best-performing sector year to date. And it feels like there is a lot of momentum in their business now.

How will a stronger Chinese currency affect hardware?

Obviously a 2% increase in costs of goods sold is going to drive some kind of inflationary pricing pressure. But on the whole, I don't think it's going to be that relevant. Tech hardware tends to have pricing compressing at a rapid rate all the time. So 2% is a rounding error.

The bigger picture long-term question is that a lot of tech companies have relocated a large part of their workforce overseas, which means they may get inflationary wage pressures in those markets. But in terms of the near term, I don't think it will have a real big impact. Furthermore,


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prices its chips in dollars, so every processor they sell will be 2% cheaper than it was before the revaluation. To the extent there is elasticity on the demand side, that's a good thing.

Any idea where investors should be looking for the next killer app?

When tech was less mature, there was an ability for a single, easily identifiable product to drive things. You don't have that any more. Tech has grown up. It's more mature. There are a lot of different product cycles now driving the market. There are a lot of exciting things for consumers to buy and its going to ebb and flow that way. You have a diversity of product cycles that are maybe smaller than the killer app we looked for in the past, but are really driving pretty good IT spending across the board.

You'll never be able to identify the killer app until it's too late anyway. People get too excited looking for one thing and they miss the forest for the trees. They need to realize how many nice, smaller product cycles are going on now.