By ALison Wright, investment manager at Britannic Asset Management Technology investors have witnes...
By ALison Wright, investment manager at Britannic Asset Management
Technology investors have witnessed a 55% rebound in the Nasdaq index since October 2002. Over the next six to 12 months, we believe we will see further gains, albeit of a much lesser magnitude.
Recent gains are easier to rationalise in terms of behavioural factors than on fundamentals. IT spending growth is expected to rise modestly this year following a 1% decline in 2001 and flat spending in 2002.
The Gartner group is currently predicting an increase of 5.8% in 2003 with 6.7% in 2004/5. While the latter forecast may prove optimistic, the swing into positive territory is important to the psychology of technology investing.
More important, though, is the turnaround in earnings revisions. Technology investors notoriously focus on earnings momentum rather than absolute growth levels. So while companies such as Lucent and Nortel will still lose money this year, for the first time in three years, they have actually been losing less than people expected. We remain somewhat positive on the sector because we believe earnings estimates are reasonable and positive revisions in estimates will continue to have a positive correlation with stock prices.
Expectations for the second half of the year are higher but do not call for anything like the type of growth expected for 2001 and 2002. Revenue growth of 5% is expected in 2003, in line with IT spending forecasts.
Earnings in the technology sector are key indicators of future IT spending trends and we believe the second quarter of this year will be the third consecutive quarter in which S&P 500 earnings have exceeded expectations.
The better than expected results in the financial and telecoms sectors are particularly encouraging. There is no emerging 'killer' application to encourage increased spending but higher capacity usage in areas such as storage will drive a need to increase spend after three years of flat to declining investment. Technologies such as Wi-fi, Voice-over-IP, digital cameras and notebooks will simply add icing to the cake.
Valuations remain the main concern for technology investors, so we should put the recent rise in share prices into context. The technology-laden Nasdaq is still down more than 65% since 2000 compared to a decline of 36% in the S&P 500.
Valuations are undoubtedly stretched in the sector, particularly if you focus on a P/E basis. However, semi-conductor and PC hardware stocks are still at the low end of their 10-year trading ranges, on a price- to-book basis.
Valuations may also be helped by consolidation in the sector. There are high cash levels at the large-cap tech companies so we expect further acquisitions like the proposed Oracle/Peoples bid and EMC/Legato agreement.
Valuation levels are not extreme enough to be a reason to invest in or avoid the technology sector. We are positive in the near term, given reasonable expectations, but cautious against over-optimism based on high expectations of 9% revenue growth in 2004. If earnings in 2004 results disappoint, as they did in 2000, valuations will once again come back to haunt technology investors.
2003 expectations beatable.
More consolidation expected in the sector.
Non-tech profit rises bode well on IT spend.
Valuations on a P/E basis are stretched.
Growth expectations for 2002 less beatable.
Lack of killer IT applications.
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