After two years of stock market heartbreak, a few hardy souls continue to seek out tech names. But given uncertain revenue outlooks, fund managers these days look to classic stock-picking measures like gauging balance sheets and free cash flow.
That's yielded some surprising contrarian tech picks, say buy siders -- including distressed names like
. But because under-the-radar tech stocks remain highly volatile, still-cautious managers are keeping their holdings small. In other words, even individual investors with plenty of stomach for risk should tread lightly.
And it's worth noting that other buy siders have eschewed bottom-fishing, remaining firmly on the sidelines. Taking a more skeptical view, they say tech managements haven't sobered up enough and retooled their companies for the postboom economy.
"It's more interesting and rewarding to buy a high-quality company that's sold off a lot in the downturn than to try to pick off broken tech stocks for a trade," says Chris Bonavico, manager of the
Transamerica Premier Growth Opportunities fund.
, the vocational training outfit. "It offers a remarkable outlook without the nosebleed risk," says Bonavico, who bought the stock when it dipped to below $13; it's since rebounded to $17. "There's clearly a need for their services because of the competitive intensity" of the job market, he says. Plenty of tech companies, at this point at least, would have a harder time explaining where demand lies for their products.
That's only one of the reasons he's been steering clear of the area. "Tech still seems to have managements that are expecting a '90s type of growth and overcompensating themselves in a way that we don't think is going to create shareholder value," says Bonavico. "Plus, there's overcapacity and they're still geared for the quote-unquote comeback."
Certainly, even managers who've bought into tech say they don't expect demand to pick up soon. "Are things going to turn immediately? Absolutely not," says Chris Beck, manager of the
Delaware Small Cap Value fund. "There's nothing to suggest from the data we have that the businesses are turning."
But, he adds, "It looks like it's stabilizing, which is the first key. The stocks will probably move two or three quarters before
there is visible improvement in the business. But what we're all watching is that the rate of decline has started to slow down, almost across the board."
Looking for Mr. Goodstock
Beck started picking up a few battered tech names last summer, when the sector took a dive. He ran a screen to sift out companies that could meet two parameters: They generated free cash flow and they claimed cash on the balance sheet equivalent to at least 50% of market cap.
Eventually, that led him to
. Back in October, Storage Technology was selling right at book value, around $10, he says -- down from its peak of $48 in 1998. Its diminished market cap meant it fit within the $2 billion cutoff for his small-cap fund. "They would not have come close to qualifying until about June and October of last year," says Beck.
For its $10 price tag, Storage Tech offered a generous $5 a share in cash and $1 a share in free cash flow. Beck, who bought some for his fund at the time, thinks it still has some upside, though the stock has since surged to nearly $24.
Another holding is Amdocs, which offers customer service and business management software to telecom and regional Bell operating companies. Not surprisingly, given its customer base, it has suffered through a tough couple of years. The market cap peaked at around $18 billion, but by last fall had shriveled to under $2 billion (though it's since added back a little). Beck bought it for around $8.50; the stock claimed $2.50 in net cash after debt and was generating around $1.50 of free cash flow.
"If a company is able to generate free cash flow, particularly when times are tough, then when good times come it should be coining it," says Beck. The combination of free cash flow and cash on the balance sheet offers some downside protection for both companies, he says.
As another risk-control measure, each stock accounts for only a tiny percentage of the fund's holdings. Storage Tech is a little less than 1.5% of assets; Amdoc is a little more than 1%.
"If the market goes into another correction phase where it's down 15%, these are going to get hit, too," acknowledges Beck. "But at least there's some value there, that hopefully either the companies can start buying back stock or initiate a dividend. They all have the wherewithal in terms of cash if they choose to."
Parnassus fund, manager Jerome Dodgson has somewhat bigger stakes in Agere and Vitesse, which account for around 3.5% and just under 3% of his holdings, respectively. Both companies are losing money, though they have significantly narrowed their losses from last year's levels.
He thinks each could rise as high as $4.50 or $5 from their current levels. Agere closed Wednesday at $1.48 and Vitesse at $2.20. "We think each can eventually earn more than 50 cents a share. Not this year. But we think with the economic climate changing, they could be earning at that rate by the end of 2004," says Dodson.
Multiplying 50 cents in forward earnings by a conservative P/E multiple of 10 yields a stock price of $5. "That would mean a little more than a double for Vitesse and more than a triple for Agere. If we're correct, there's a lot of substantial upside," he says.
With growth still elusive, contrarian stories like these offer some interest -- the prospect of a decent balance sheet and, presumably, an upwards earnings trajectory.
But when it comes to tech, other buysiders offer useful caveats to keep in mind. "A strong balance sheet is always important, but there has to be an operating business with a good long-term outlook to invest in with that cash," says Bonavico. "Just holding cash is of no particular benefit unless there's an operating business to invest in. There are so many stocks out there that have very little demand for their products or services, and a cash balance."
In fact, companies that sit on a lot of cash may not be doing shareholders any favors. Consider that a company's cost of capital is typically at least 15%. "So they better be investing in their operations and earning higher than 15% to really create any value," explains Bonavico. "If they've got equity outstanding and they're sitting there with a cash balance earning 2%, it's destroying value."