Thursday, November 7, 2013

Investing in Technology Stocks

I went to see Keith Weiss, software analyst at Morgan Stanley yesterday.  He made a good presentation on the stocks that he followed, but I particularly liked one of his charts which I have posted above.

Although his chart only focuses on the stocks he follows, it illustrates very well the challenge for portfolio managers interested in the technology space.

Most of the tech area breaks down into the three sectors that Keith displays.  First there is the "value" sector which usually includes older tech companies whose best growth days are behind them but still are incredibly robust and profitable companies.  Good examples in the software space would be Oracle and Microsoft, which both trade at a discount to the S&P 500 but still are obviously major players in the technology area.

Then there's the middle sector, which Keith calls "story stocks".  These are stocks which usually trade at a premium to the market multiple since their growth rates are still strong and the potential for future gains are still ahead.  In the software arena, this would include companies like VMware and Red Hat.

Finally there are the dream stocks that Keith has called "hyper-growth". The valuations of these stocks makes no sense until you realize that the growth rates of these companies are incredible.  In Keith's universe these are names like and Fireeye (I suppose Twitter would also fall into this category but Keith does not follow the company).

Bernstein Research has looked at the past performance of tech stocks, and has found that a barbell approach involving value tech and hyper-growth tech tends to outperform over time. The stocks in the middle - the story stocks - usually wind up being laggards.