Seeking Steady Growth In Technology Stocks

OCEAN CITY — For the past decade or so, many investors seeking the potential for steadier growth have avoided the tech sector, thanks in part to its association with the dot-com bubble of the late 1990s and early 2000s. But today the landscape for technology companies is markedly different. In fact, investors seeking potential stability may well want to look to the sector — not necessarily to headline-making startups, but to more mature, nuts-and-bolts companies that manufacture and market computers and information technology services.

Having survived the tech bubble as well as the more recent recession, mature tech companies currently have strong fundamentals that could make them good opportunities in both bull and bear market scenarios, observes Savita Subramanian, head of U.S. Equities Strategy at BofA Merrill Lynch Global Research. "Some of the larger, cash-rich, less ‘exciting’ technology stocks could do well over the next few years," she says.

For starters, Subramanian notes, many of the more fragile tech companies fell out of favor during the shakeout a little over a decade ago or in subsequent recessions. Our research indicates that the survivors have emerged hardier and healthier. As the cost of capital dropped from 2002 to 2007, financials, industrials and materials companies added more debt and expanded capacity. By 2008 those sectors "were the most leveraged and most geared to collapse during the credit crisis," Subramanian says. "Meanwhile, technology did the exact opposite. Tech took its lumps back in 2000 and spent the next seven years consolidating capacity. The sector generally avoided debt, so it ended up in a better position."

Having stayed lean and mean, technology weathered the recent downturn better than many other sectors. In fact, Subramanian notes, technology is the only cyclical sector whose earnings have actually become less volatile during the past 10 to 15 years, owing largely to tech companies’ minimal debt and abundant cash. "Many investors are surprised by that," she says.

Indeed, like many other businesses that hunkered down during the recession, technology companies have been accumulating cash. With their balance sheets currently healthy and their profits stable, many tech companies have recently begun using this cash to buy back their own stock—potentially boosting its price—and to fund new or expanded shareholder dividend programs.

Whereas technology stocks in Standard & Poor’s 500-stock index have historically traded at a 25% premium relative to the overall equities market, today the sector is trading at a slight discount, largely because expectations of tech-sector growth have been at all-time lows. "That’s a very different environment from the past," Subramanian says. "Technology seems inexpensive today. Even if you take out the tech bubble period, technology is still trading at a 20% discount relative to its normal valuations."

Despite decade-old fears about investments in technology, Subramanian suggests that those seeking growth may want to take a new and unemotional look at the sector’s hard numbers. Such investors should also look at their own expectations for growth and their risk profile. They may ultimately conclude that these potentially healthy, stable, mature, dividend-producing tech stocks have earned a place in their portfolios.

(A Merrill Lynch senior financial advisor, who can be reached at 410-213-8520.)