Three Long-Shot Tech Gambles That Could Pay Off Big - TheStreet

I'm going out on a limb to find stocks that should leave the mill wheel behind for steadier growth -- if that recovery ever gets here.

I've been looking for signs that any technology company is ready to start producing the steady, predictable growth that could let its shares step off the current treadmill.

You know the treadmill I mean. One month the technology sector races ahead as if the bull is back. The next, it reverses course and looks as if it could give back all it gained.

But I think I've found three technology stocks that may have the potential over the next quarter to break away from the milling crowd. I'd call them long shots right now. The signs of a business recovery at each are promising but very easy to overinterpret. And any recovery, even if real, is all too subject to reversal given the immense uncertainties in the global economy.

That said, I think these three stocks are worth studying over the next few weeks to see if the early signs of a business recovery are real. And with earnings-warnings season just around the corner, there's a good chance each stock's price could drop, which would sharply reduce the risk of these long shots. I'm not adding these to Jubak's Picks now -- I'd call them "Wait to buys" if the business news and the prices go the right way.

The names? In alphabetical order:

Brocade

(BRCD)

,

Extreme Networks

(EXTR) - Get Report

and

QLogic

(QLGC)

.

Half-Full or Half-Empty?

Why those three? Because of my read on the general market for technology stocks and because of some recent news on how business is shaping up at each.

Just two months ago, investors saw the glass as half-full. Looking at crushed technology stocks, we saw a bottom. Business was so bad, we figured that it had to improve. With visions of second-half sugarplums dancing in our heads, we bid the technology-heavy

Nasdaq Composite

index up 41% from April 5 through May 22.

Sentiment turned on June 7, when the Nasdaq Composite closed at 2264. In its midquarter update after the market close on that date,

Intel

(INTC) - Get Report

didn't say anything bad, really. But the

absence

of bad news wasn't enough to keep technology stocks propped up, and the sector began to drift lower. And warnings from

Hewlett-Packard

( HWP),

National Semiconductor

(NSM)

and

Nokia

(NOK) - Get Report

have each taken a bite out of investor confidence. The glass increasingly seems half-empty.

On June 13, for example,

The Wall Street Journal

ran a page 2 article with the headline "Dell, 3Com, Among Others, Announce New Layoffs Amid Economic Slump." And with earnings-warnings season just getting started, it's likely to get tougher over the next few weeks to believe that sentiment will ever reverse.

But it's likely that sentiment will do exactly that. Just as April's rally on actual earnings news followed March's barrage of earnings warnings, so too could we expect a bounce in July once all the bad news is disgorged in June. After the crescendo of warnings in the last weeks of June, a company report that merely meets expectations will set investors' hearts racing. And think what a "surprise" of a few pennies, when a company "beats" lowered expectations, will do for a stock when investors have felt so negative for so long.

Will a July rally -- if it materializes -- mark the great turning point that we've all been waiting for in the technology sector and the resumption of something that resembles the bull market for tech stocks of 1999? I doubt it.

For one thing, after a bear market as vicious and long as this one has been, stocks don't immediately jump back into a consistent rally mode. They race up and drop back, race up and drop back. If investors are lucky and the sector has found a true bottom, each rally tops out at a slightly higher level and each drop reverses above the previous low. (That's the way the market was developing until June 7, when the Nasdaq temporarily topped out without setting a new high. And that's why the current market pullback is making so many Wall Street professionals nervous because it could be a sign that we haven't yet really started the healing process.)

Also, the economic news for technology stocks as a whole and for individual companies remains terribly uncertain. For example, on June 13

Cisco

(CSCO) - Get Report

told analysts that sales were OK for its edge routers but weak for products designed for the core of the Internet. International markets didn't look great either, the company noted. The near-term outlook, according to Cisco, is best described as cloudy.

Nokia said essentially the same thing when it warned for the June quarter on June 12. At that time the company refused to give any update for the second half of the year. The outlook was just too uncertain. Until companies can provide better visibility than this on their prospects for the next few quarters, investors will continue to vacillate between hope that the next quarter will mark the long-awaited turn in business and fears that the turn has been pushed out to the first part of 2002.

Enterprise Spending on the Mend?

There's one segment of the technology sector that is showing the beginning signs of that kind of increased visibility. Oddly enough, given all the bad news we've heard about a recession in capital spending -- that's the view from the

Federal Reserve, for example -- the good news is coming from technology companies that sell software and hardware to corporations for their own use, in what's called the enterprise market.

The signs of a pickup in enterprise spending are scattered and anecdotal, but I find the pattern promising. For example, in an April survey of 200 corporate information technology managers,

CIO Magazine

found that 50% of respondents thought they would spend more on networking and communications gear over the next 12 months than they had over the past 12 months. About 80% said that recently their spending plans for the next 12 months had changed either for the better or not at all. For example, in early May, Extreme Networks told analysts that it was seeing solid bookings for April and improving visibility for May, and on June 12 the company's CFO confirmed that to

Merrill Lynch

.

April and May have turned out to be stronger than expected, the company said, and business in June seems to be accelerating. The June quarter is turning out to be the most linear in a year. Translation? Extreme's customers aren't waiting until the end of the quarter to place orders in hopes of negotiating lower prices. On May 16,

Banc of America Securities

said that QLogic was positioned for sequential growth starting in the September quarter (sequential growth is where revenue and earnings for each quarter come in higher than the quarter before). On June 11, Merrill Lynch said that Brocade's May quarter was on plan, and two days later the company said it was comfortable with analyst expectations for the June quarter.

However, the pattern is promising rather than convincing, in my opinion, because Europe has become a troubling wild card for U.S.-based technology companies. Recent warnings from Hewlett-Packard and Cisco have mentioned slowdowns in sales in Europe. And it's not clear to me at this point if that slowdown will affect Extreme, QLogic and Brocade -- although I assume it will -- or how big the effect will be. I'd prefer to wait for these companies' June numbers and their guidance on September before I jump.

I don't think the stocks will run away from me in the next few weeks, either; enough related-technology companies should be issuing warnings to keep pressure on these three stocks, even if these companies don't warn. QLogic got pummeled on May 30, for example, when customer

Sun Microsystems

(SUNW) - Get Report

warned. QLogic fell $7.45 a share that day, or 13%.

Remember, I said that these stocks have a chance to break away from the technology treadmill. They still have to prove that they can.

At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column.