The Tech Boom Will Keep On Rocking
Introduction: Investing in Technology
Nelson D. Schwartz
John Morgan would never pass for a Silicon Valley player or a Wall Street hotshot. A native of tiny Madison, Ala., the 43-year-old computer specialist has always been a conservative investor, buying shares of high-tech blue chips like Intel and Microsoft and holding them for the long haul. Conservative, that is, until last fall, when the mild-mannered Morgan made a quick trade so profitable that even the big-city dudes would be impressed.
With his Microsoft and Intel doing well, Morgan decided he could afford to take a flier on Amazon.com, a company he had gotten to know as a repeat customer. Opening a margin account for the first time, he bought 100 shares of the online bookseller in late November at $189, without putting a penny down. By the time he got out in early January, Amazon had soared to $460 a share, earning Morgan a $27,000 profit in just seven weeks.
"It didn't feel real," he says. "It was like putting a dime in a slot machine and having $27,000 come out. But this shows that the average investor can participate in what's going on in technology. If I can do it, anyone can."
Maybe he's right--or maybe he's just lucky, a novice surfer who somehow managed to catch a gigantic wave. Either way, Morgan's story helps illustrate how tech investing has arrived on Main Street. Whether you're scanning Websites like Silicon Investor or watching CNBC, it's clear that buying tech stocks is no longer just for professional money managers or risk-addicted traders with mad money on their hands.
Anecdotal evidence suggests that retail investors, rather than pros in the canyons of Manhattan, are behind the dizzying rise of stocks like Amazon and Yahoo. Historically, that's often been a sign of a market peak, and this time around may be no different. (Morgan seems smart to have gotten out of Amazon when he did--it has since skidded roughly 20%.)
The Internet stock frenzy aside, there are real-world trends that help account for investors' love affair with high tech. Everyday experiences like reading e-mail or buying a book online underscore the degree to which technology is transforming our lives. We also see the companies we work for glomming on to tech as if there's no tomorrow: Global competition and the ever-increasing pressure for productivity gains have made new tech investment an absolute necessity for most businesses, not a luxury reserved for good times. That's one reason global software spending should grow from $130 billion in 1998 to roughly $230 billion in 2002, according to Mike Kwatinetz, director of technology research at Credit Suisse First Boston, and the $15-billion-a-year market for PC servers, the workhorses of modern corporate computing, should more than double. The growth potential of the companies leading this revolution dwarfs that of old-line blue chips. Explains strategist Tom Galvin of Donaldson Lufkin & Jenrette: "In this kind of market, where most companies are generating lackluster earnings growth, you want to own what's still growing rapidly. Tech is where the growth is."
Galvin, of course, is in the stock-selling business, but the surging stock prices--and valuations--of high tech's biggest names reflect a similar logic. While the average S&P 500 company's earnings dropped 3% in the third quarter of 1998, Cisco's profits jumped 31%. EMC's increased 52%. And Microsoft's surged 56%. Maybe it's no surprise that eight of the top ten performers in the S&P 500 in 1998 were tech stocks. And the pattern seems to be continuing in 1999. In late January, IBM reported better-than-expected earnings for its latest quarter, as did Sun Microsystems.
Does this mean that windfalls like Morgan's will be more common in the coming year? Probably not. While the fundamental prospects for the tech industry are as rosy as ever, tech investing is getting downright thorny. The surge in stock prices, along with ever-expanding P/Es, makes many stocks far riskier than many investors realize.
Still, avoiding tech would be a huge mistake, given the kind of profit growth implied by the trends we're about to discuss in the coming pages. Instead, investors will have to become pickier about the companies they buy, more aware of how to balance the risks in their portfolios, and better prepared for the broad trends sweeping the tech industry.
In other words, they will have to think like venture capitalists. Whether they know it or not, that's what individual investors have already become, says Mark Cuban, president of Broadcast.com, a Dallas company that broadcasts audio and video programming via the Internet. Until about three years ago, Cuban notes, going public wasn't an option for companies with an exciting concept but a dearth of earnings. They had no choice but to rely on venture capitalists for the first few rounds of financing and could launch an IPO only once the profits started to flow.
That changed with the explosion of interest in the Net and the success of Netscape, the first big Internet IPO. Now, says Cuban, investors like you, me, and John Morgan serve as the backers for embryonic companies. Cuban isn't theorizing--he's speaking from experience. "Instead of going for another round of venture capital, Broadcast.com did an IPO," he says. "In essence, we used the public market as our VC."
A quick comparison of the IPOs of Microsoft and Amazon.com illustrates the change. When Microsoft went public, it had been in business for more than a decade; it earned $24 million in the year before its IPO. Amazon.com, on the other hand, went public less than three years after it was founded. It's not expected to turn a profit until 2001.
Unfortunately, this new venture-capitalist Everyman may not understand what he's getting into when he buys Internet stocks (a better name might be adventure capitalist). Unlike Silicon Valley Medicis, retail investors don't usually have the opportunity to sit down with management or talk to customers and competitors. And while traditional venture capitalists have years of experience on Wall Street or in high-tech startups, neophyte investors frequently find themselves relying on boosterish analyst reports or the latest chat-room discussion for company info. Keep in mind, too, that venture capital investing involves very different odds from those of traditional stock picking. As Cuban points out, VCs typically assume that nine out of every ten companies they back will fail. The profits come when that one successful bet turns out to be a "ten-bagger," Wall Street argot for an investment that yields a tenfold return.
For less sophisticated adventure capitalists, the odds are probably a whole lot worse than one in ten. Even tech bulls like Credit Suisse First Boston's Kwatinetz are quick to cite the risks of Internet stock investing. "Look," he says bluntly, "you don't want to put the rent money into Yahoo or any Internet stock."
If you're comfortable with the odds and have both the emotional and financial reserves to withstand a total loss, however, Internet highfliers may have a place in your portfolio. Then a way to play is to emulate VCs by buying shares in a bunch of companies, so your chances of landing that rare winner are greater. Make sure your stock basket is representative of the entire Internet spectrum. That means including both pure Internet plays such as Lycos or @Home Network and e-commerce ventures such as Amazon.com or Beyond.com, a software seller. Finally, mix in the closest thing the Internet space has to blue chips--AOL and Yahoo. Yes, their valuations are sky-high, but they do have actual earnings, along with management teams that are well respected on Wall Street.
For everyone else hoping to profit from the tech boom, the prudent approach is to go with established players like Microsoft, Intel, Cisco, and the newest name in this pantheon, EMC (see "Storage! Storage! Storage!" below). All four stocks have sizable P/Es and are certainly not risk-free. But these companies' earnings are projected to grow by an average of 25% in 1999. Intel alone should post a 33% jump. That's nearly twice the expected earnings growth of the S&P 500.
The year is also likely to be good to two other preeminent tech companies, IBM and Dell. While IBM's revenue growth is far weaker than Cisco's or Microsoft's, its big share-buyback program, a continuing focus on margins, and burgeoning strength in services and software should please Wall Street. Dell, meanwhile, will benefit as Y2K fears boost computer sales, especially in the first half of the year. That, along with continuing market-share gains, helps explain why Wall Street has awarded Dell a Texas-size P/E of 80. Bright as the future is for such giants, not even Dell will generate overnight riches at quite the pace of the next Internet phenom. But the giants are also a lot less likely to wipe out their investors--an important consideration in a sector that's changing as fast as tech.
Just ask John Morgan. Although his investing coup with Amazon has led him to consider buying some other Net names, he wouldn't dream of cashing in his shares of Microsoft, Intel, or Cisco to do so. "I'd never sell one of those to buy an Amazon," he says. For that matter, neither should you.
For more investing ideas--and a tour of the fundamental forces impelling the tech boom--check out the following pages. The ten trends we highlight make up a savvy scorecard for analyzing the action in the rough-and-tumble infotech markets. You'll read it here first: for example, how and why Microsoft and Intel are subtly drifting apart, as well as how close we are to the day when PCs are simply given away. You'll discover a handy gazetteer of millennium buzzwords--you can be the first in your office to speak knowingly about how your company is becoming an "infomediary."
Our prognostications should tantalize technology users. This will be the year that cell phones will really get smart; when personal digital assistants, thanks to wireless connectivity, will really begin to be of some assistance; when you won't know or care whether your phone call is being routed through phone lines or through the Internet; and when you can finally talk back to your TV. As our own top technophile, Joel Dreyfuss, puts it: 1999 is the year that "the IQ of digital devices rises while the IQ needed to make them work declines." Now that's progress you can bet on.
Introduction: Investing in Technology
1. The Exchange Economy
2. Phones Get Swallowed
3. AOL Rising
4. Storage! Storage! Storage!
5. PC-Free Devices
6. Supersmart Cellular
7. The Y2K Play
8. Freebies Galore!
9. The Morphing of Intel
10. Microsoft Waning
Magazine Issue:Vol. 139, No. 3, February 15, 1999
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TEN TRENDS Introduction: Investing in Technology
1. The Exchange Economy
2. Phones Get Swallowed
3. AOL Rising
4. Storage! Storage! Storage!
5. PC-Free Devices
6. Supersmart Cellular
7. The Y2K Play
8. Freebies Galore!
9. The Morphing of Intel
10. Microsoft Waning
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FORTUNE's Bethany McLean |
