Technology Stocks Power Wall Street
By Tim Smart
Washington Post Staff Writer
Friday, February 19, 1999; Page E1
As the decade began, four oil companies ranked among the top 15 stocks
in the Standard & Poor's index of 500 companies. Today, there's only
one. And a company that didn't even make the top 50 stocks a decade
ago – Microsoft Corp. – now holds the coveted top spot once occupied
by Exxon.
The top tier of the S&P 500 – considered the broadest measure of the
stock market and the barometer used by many mutual funds to track
performance – today is dominated by technology companies. Besides
Microsoft, there are six computer or telecommunications firms among the
15 most highly valued companies in the index.
Tech stocks "are the market," said David Barnard, a senior portfolio
manager for the AIM family of mutual funds in Houston.
The prominence of tech stocks in the S&P is one indication of the extent
to which tech issues have gained value in the past decade. Yet their
increased worth also poses a danger: In this more narrowly focused
market, the inherent volatility of fast-growing tech stocks makes Wall
Street more vulnerable to downswings.
The market is a "one-legged bull," said Warren Smith, managing editor of
the Bank Credit Analyst research group in Montreal. "The raging debate
in the market is: If we knock that leg out, do other legs develop? I do
think there's a sense of the market searching for leadership."
Largely on sharp movements in tech stocks, the market lately has zigged
and zagged with abandon, as it did again yesterday, with the Dow Jones
industrial average gaining 103.16 after losing 101.56 Wednesday.
Just how much the market relies on technology for its oomph is illustrated
by data Smith has collected on the performance of the S&P 500 index
since January 1998. The index is up about 26 percent since then, but
when tech stocks are excluded, the index is actually down by 2 percent.
Their stellar returns have also enabled the S&P in recent years to vastly
outperform the much better-known Dow. In 1998, for instance, the S&P
rose 26.7 percent while the Dow was up only 16.1 percent. The
even-more tech turbocharged Nasdaq composite index gained almost 40
percent in that period.
"Technology, communications and Internet-related stocks are starting to
dominate the S&P," said Jim Branscome, a senior vice president at the
ratings service. Branscome notes that technology as a sector accounts for
18.5 percent of the total value of the S&P 500, compared with consumer
cyclicals – a mixed bag including such categories as autos, clothing and
newspapers – which make up 9.2 percent of the index.
As tech stocks grow in importance, some investors question whether the
Dow is the best barometer of the market. Most mutual funds, for instance,
compare themselves to the S&P; The only tech stocks among the 30
companies in the Dow are International Business Machines Corp. and
Hewlett Packard Co., which was added in 1997.
Partly to keep up with the changes, Dow Jones this week introduced a
new index of Internet stocks, and the S&P recently added America
Online Inc. to its list of 500 companies.
The addition of Dulles-based AOL is the latest example of how the S&P
has changed dramatically in the past decade. Microsoft represented 3.5
percent of the S&P index's value at year-end 1998. When Exxon Corp.
was No. 1, it accounted for 2.7 percent of the S&P's value.
It's not just Microsoft that has become highly valued. Other tech
companies have also risen to the fore, with Intel Corp. at No. 3 and Cisco
Systems Inc., Lucent Technologies Inc. and MCI WorldCom Inc. now in
the top 15.
Correspondingly, the oil companies, once considered the most powerful
corporate entities on earth, have fallen far in the past decade. Now only
one, Exxon, is in the top 15. Today, Dell Computer Corp. outranks both
Amoco Corp. and Mobil Corp., companies that dwarf Dell in terms of
revenue.
But, as Barnard notes, there's a compelling reason for tech stocks'
popularity. It's the same rationale that Willie Sutton used to explain why he
robbed banks: That's where the money is.
Investors buy stocks for their earnings potential – a stock is actually a
prepayment for a future stream of income paid out either in dividends or in
the increased value of the stock over time.
Well, guess what? At a time when corporations overall are reporting a
slowing in the rate of earnings growth – in the fourth quarter, profits rose
at 3 percent year over year for all publicly traded companies – technology
firms are still romping along. Earnings among companies in the tech sector
rose 64 percent in the fourth quarter from a year earlier.
And it's not only that the profits of technology firms are growing more
rapidly than their industrial brethren. They are also far more profitable on
an absolute basis. Microsoft has an operating margin – its profit as a
percentage of revenue after expenses but before taxes – of about 48
percent. That compares, say, with DuPont Co., a former top 10
component of the 1980s-era S&P, whose margin is closer to 14 percent.
To many who follow the market, this disparity in performance highlights
how the U.S. economy has changed in the past decade.
"We've moved from an industrial economy to an information economy,"
Barnard said.
Yet an often overlooked fact about technology companies is that, just like
the industrial giants they are replacing, they are cyclical in nature. Today,
they may well be at the peak of a capital spending cycle.
"This is a great place to be longer term, but it's a cyclical industry," says
John L. Manley Jr., an equity strategist at Salomon Smith Barney. Manley
says even with the February pullback in some well-known tech stocks,
they are still beating the rest of the market by about one-third.
That's a premium the sector hasn't commanded since the hoopla over the
IBM mainframe computer in the 1970s and again for the 1995 launch of
Microsoft's Windows 95 operating-system software.
Some experts attribute the divergence to mania over anything tied to the
Internet. Indeed, Interet stocks such as AOL and Yahoo Inc. have been
among the market's most spectacular performers in the past 12 months.
But even the most pro-tech strategists question whether the run-up of the
past year has gotten ahead of itself.
"The Internet clearly will change the world," Aeltus Investment
Management strategist James Griffin Jr. wrote in this week's edition of his
client newsletter. "But it is not equally clear that this will justify any price
paid."
The same can be said for the more established tech stocks. But for now,
most investors are choosing to stick with them. Even Manley, who is
cautious about the current valuation of tech stocks, says he won't change
his advice to load up portfolios with tech issues.
"Five years from now, I'll be very surprised if the aluminum industry or the
paper industry is a bigger chunk of the economy than technology," he said.
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