Investing in the Technology Sector Stocks

By: Hans_Wagner

To beat the market investors need to be in the right sector and sub-sector. Money in markets tends to flow from one sector to another based on investors perceptions of what is fundamentally driving the underlying business. The basic theory behind sector rotation was described by Stan Stovell in Standard & Poor's Guide to Sector Investing 1995 (this is an expensive book). However, as I have discussed in previous articles on sector rotation, the movement of money is a bit more complex and not quite as straight forward. In this article I present a couple of the underlying themes that are driving the technology sector to help identify investing opportunities.

Using themes to identify new sectors

The investing theme should be clear and simple since there only a couple of key factors that determine the trend for the sector. Most of the time it involves what is driving the supply and demand for the products or services within the sector. For example in the energy sector the demand for oil throughout the world is growing as emerging economies grow rapidly and create new demands for energy. The available supply will become more expensive to find and new alternatives will be needed to keep up with the demand. From this overall theme, you can then focus on each sub-sector to assess where the best opportunities will lie.

Continuing the example, the need for new supply will drive up the demand for those companies that can contribute to the exploration and development process for oil. This means the oil services companies should benefit. Three years ago the Oil services Holders (OIH) was trading in the 90 to 100 range. Recently it reached 200. A very nice return if one had identified and followed the theme.

When you are creating your theme, or borrowing from one's you have heard and like, be sure to look up and down the “supply chain” of the sector. You might be surprised by what you find, even in a different sector. For example drilling deeper for oil requires newer and better pumps and valves. Flowserve (FLS) designs and produces pumps and valves for the energy industry as well as others. It is classified in the Industrial sector, yet it benefits from the search for oil.

Technology Sector

The technology sector has been undergoing a long period of consolidation after the dotcom bubble of 2000. However within the sector a number of interesting changes have been taking place that are of interest to investors. 

Probably of most importance is the performance of the semiconductors relative to the overall market. It seems that we are seeing a definite slowing in the growth of this important segment, possibly due to the commodity nature of the industry. For example, Nokia recently changed its chipset strategy to focus only on model chips. It intends to leverage the capabilities of other semiconductor companies. Nokia believes that there are better returns in software and services. The consolidation of the semiconductor industry is inevitable in order for the capital intensive industry to survive. This tells me that the semiconductors companies are becoming like commodity suppliers. This will cause a transition in the industry that will take some time to complete, resulting in slower growth until the changeover is complete. 

The example below from stockcharts.com describes quite well the divergence that is taking place between the internet companies ($MOX index) and the semiconductors ($SOX index). It confirms that investors are still not valuing semiconductor companies as they lack the pricing power that the internet companies have.

Other changes that are more relevant to the development of our themes include:

• Wireless and mobility devices continues their rapid growth, as new devices continue to expand their functionality and the younger generation is no longer tethered to the wireline telephone;
• Broadband and especially video is becoming an essential part of networks from the internet both wired and wireless;
• Security grows in importance as the internet becomes a primary way of doing business; and
• Applications are making software the most important part of the technology value chain.

Themes and Potential Companies

Each of the changes mentioned above represent potential investing themes. They describe a business situation with growing demand for a product or service. In addition they are fairly easy to understand and follow. Assuming you accept them as potential investing themes, all that is left is to identify companies that should benefit.

Wireless devices continue to grow in demand as broad band capabilities are extending to the devices with the roll out of third generation (3G) capabilities are made available at quite good prices for customers. Well known companies such as Nokia (NOK) and Research In Motion Ltd (RIMM) have benefited greatly, while Motorola (MOT) has encountered difficulties, though a turn around may be underway. Apple (AAPL) has entered the fray with the iPhone. Then there are the companies that are benefiting from the benefits from global positioning such as Garmin (GRMN) and Trimble Navigation (TRMB).

In the broadband and upgrade of the internet we see a number of companies that should benefit. Motorola (MOT), Cisco Systems (CSCO) Juniper Networks (JNPR) and Harris Corporation (HRS) are some of the companies that have a stake in the upgrades to the capabilities of the internet that are currently underway.

Security remains a significant concern to all who use their personal computing devices. Blue Coat (BCSI) is a relative new member to this arena that includes Symantec (SYMC) and McAfee (MFE) among others. 

There are many software application providers but an interesting play is Akamai (AKAM), a company that helps firms to manage and distribute the applications across the corporate network.

The point of this review is not to recommend specific companies for investors to consider, but rather to emphasize that they need to have a clear and simple statement that describes the investment concept before committing their hard earned capital. 

The Bottom Line

Each sector in the market has a set of relevant themes that can be developed to help investors to articulate their view of the opportunity. As markets evolve over time it prudent to consider the sectors that deserve the most attention and your capital. Developing a theme that describes the investment opportunity in clear and simple ways is an important part of any sector analysis. Then it can be used to help find the best companies can take advantage of the theme. 

When developing the theme for the sector, be sure you look at the risks that are inherent with the theme. These risks might the trigger you need to know when to sell, reduce your position, or switch to another sector or sub-sector. For example, if the price of oil gets to high it is in danger of causing the economies of the world to slow down, possibly causing a recession. Periodicals like Barron's. usually present interesting factors to consider when evaluating sector themes.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

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