Well, I think any statement about stock prices is always suspect unless it's made by Warren Buffett.Notably, Gates didn't specifically mention Microsoft and, typically, was more open to interpretation than Ballmer. Still, it seemed clear to me that he believes tech stocks, in general, remain overvalued. Perhaps more interesting than Gates' comments -- made after the close Monday -- was the seeming absence of market reaction to, or media chatter about, them. Clearly, we're not in Kansas, circa 1999, anymore. The relative and absolute lack of reaction to Gates' view on tech stocks says something about the sector's fall from grace, if not our collective consciousness. Imagine the reaction if Gates had said residential real estate is overvalued. The lack of response to Gates' comments and the sense tech stocks are no longer an acceptable topic of conversation in polite society might prompt a contrarian to say it's a bullish sign that people don't care about tech or have given up on the sector. Clearly, there is a lot of skepticism about technology stocks, as evidenced by the steady rise of short interest in over-the-counter stocks this year and the uneven trend of inflows into growth mutual funds. That's understandable given the sector's recent performance. Despite rallying the past four sessions, including Wednesday's 1.5% advance, the Nasdaq Composite remains down 9.8% year to date and is the worst-performing of the major averages.
But I would say that there is as much overvaluation today as there is undervaluation. People still love technology companies. People still have the dream, and there are big multiples. We're nowhere near where we were in 1999, but in no way has there been a swing in the other direction, to a measurable degree.
Timing is everything when it comes to trading stocks and, apparently, even pontificating about them. In September 1999, Microsoft's ( MSFT) then-president, Steve Ballmer, told a conference of business journalists that "there is such an overvaluation of technology stocks that it is absurd." The market's violent reaction, while short-lived and prior to a huge rally, was arguably a harbinger of the sector's 2000-02 misery. Fast forward to this week in Seattle, where Microsoft co-founder Bill Gates addressed the same conference -- the annual meeting of the Society of American Business Editors and Writers. Recalling Ballmer's comments in 1999, Gates was asked for his current view of tech stock valuations. His response:
Reflecting the zeitgeist, in the most recent issue of Fortune -- ironically, with Gates on the cover -- Shawn Tully declares tech stocks are "still trading at Brobdingnagian valuations" andeven those ostensibly bullish on the sector offer caveats (and emptors). "Valuation multiple compression remains the key issue for the sector, as there is no major application cycle and investors begin to treat technology as a cyclical reaching peak earnings," says Vadim Zlotnikov, chief investment strategist at Sanford C. Bernstein. Reflecting on first-quarter results, Zlotnikov notes the "broad deceleration is apparent in year-over-year comparisons" and "forward guidance was weak." The strategist also expresses concern about elevated inventories -- citing a $600 million increase at just Intel ( INTC) and Ericsson ( ERICY) combined -- as well as the ability of companies to meet analysts' expectations for margin growth in the second half of 2005. Nevertheless, Zlotnikov maintains a modest overweight recommendation on the sector, betting on "the possibility of a longer economic cycle" and that the trend of multiple compression will abate. (It certainly abated Wednesday.) "Perhaps, even more important than the macro bet, which will prove incorrect if rates continue to rise," Zlotnikov says, "is the emergence of both value and growth opportunities within technology." In the former category, the strategist cited Hewlett-Packard ( HPQ), Nokia ( NOK) and Lexmark International ( LXK) as companies with the least expensive price-to-earnings (forward), price-to-sales and price-to-cash ratios among large-cap tech stocks. Zlotnikov recommends EMC ( EMC), Corning ( GLW) and Google ( GOOG) as tech growth opportunities, citing their positive revisions/momentum and superior relative growth. Among tech stocks to avoid (or short), based on valuations and negative/neutral guidance, he cites Amazon.com ( AMZN), Network Appliance ( NTAP) and Broadcom ( BRCM). Sanford Bernstein does not do investment banking. The idea of being bullish on some tech stocks and bearish on others may be anathema to some investors still stuck in the sector-specific world of the 1990s. But "this is the definition of a stock pickers' market," says Chris Johnson, chief quantitative strategist at Schaeffer's Investment Research in Cincinnati.
While arguing investors remain overly optimistic about big-cap tech stocks such as Microsoft, Johnson maintains that a lot of smaller- and mid-cap tech stocks "have been brushed under the carpet because people are afraid of another multiyear bear market" in the group. From a contrarian view, that pessimistic sentiment presents an opportunity. Those willing to go against the herd might consider the iShares Russell 2000 Mid-Cap Growth Index ( IWP) or its Small-Cap ( IWO) counterpart.