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Tech Companies Learn From Past Mistakes

If you're tempted by technology funds, you probably feel like Charlie Brown trying to kick a football held by Lucy Van Pelt. You'd like to believe that the tech rally won't get snatched away as soon as you invest. But you've been suckered too many times.

Still ... the tech-rich Nasdaq stock index has soared 56 percent from its March lows, and it would be great to get some of those red-hot returns. Is it worth a shot?

Quite possibly. But before you tee up tech stocks, make sure that you don't have enough tech already.

The usual reason investors jump into technology is because it's been doing well lately. And that it has: Technology accounts for half of the S&P 500's gain since its bottom on March 9, says S&P senior analyst Howard Silverblatt. The sector now accounts for 18.8 percent of the Standard & Poor's 500-stock index, by far the largest sector weighting in the index. Energy, the next-largest sector, is 13.8 percent of the index.

Of course, those who follow red-hot performance often regret it. Anyone who bought tech in the 1990s is still seeing stars. The Nasdaq had an intraday peak of 5,133 in March 2000; it closed Thursday at 1,984, a 61 percent loss. Why invest in tech now?

One reason is that tech companies, apparently, have learned a few lessons from being treated like the stars of a decade-long Punch and Judy show. Companies that produce semiconductors, for example, were often the last to figure out when a recession hit. They were left with huge inventories of computer chips to sell at rapidly declining prices.

Not this time, says Zach Shafran, manager of Waddell & Reed Science & Technology fund. "They responded so rapidly and so effectively to the downturn that when it came to cutting production and inventory, there is not nearly the volatility in profit margins that you normally see," he says.

The tech companies that have fared particularly well didn't just hunker down during the recession, Shafran says. "They kept investing in research and development and kept forging ahead with key projects," he says. He points to Broadcom, up 51.5 percent the past six months. "It was criticized for its high R&D expenditures, but they're starting to pay off, particularly in the wireless space."

Years of constant pummeling taught many tech companies something else that many companies are just learning now: prudence. "Tech has the lowest debt position, the highest cash levels and no pension issues," says Robert Turner, president of Turner Investment Partners. "These companies have been restructuring for 10 years."

Intel, for example, had $11.6 billion in cash on its books, according to its most recent financials. Oracle had $12.6 billion. Microsoft had $31 billion.

And, Shafran says, those companies have been putting money to good use. Microsoft, for example, has never been noted as a cost-conscious company, but it has started to rein in costs. Furthermore, it has spent some of its cash on new products, such as its Bing search engine and Windows 7 operating system, that are getting grudgingly good reviews.

Another argument for tech is the enormous new product cycle in smartphones, which allow you to take calls, send e-mail, watch videos and surf the Internet while sitting next to people reading a book.

David Eiswert, manager of T. Rowe Price Global Technology, thinks tech companies will sell 250 million smartphones next year. The Apple iPhone is one of the most popular smartphones now, but the BlackBerry, from Research In Motion, also has a big following. Eiswert is intrigued by the Palm Pre and uses one. "The PalmPilot philosophy is to organize information in a way that's elegant," he says. (The fund owns Apple, Palm and Research In Motion.)

All well and good, but with tech stocks up so sharply, how much longer does this particular bull have to run? "Not quarters or months, but years," Turner says. In an economic slowdown, companies may be slow to hire new employees but will embrace technology to increase productivity.

Waddell & Reed's Shafran is a bit more cautious. "I'm not sure I have a good answer," he says. "Visibility is limited." His fund's general caution, incidentally, is one reason it's a long-term leader.

If you own a broad-based fund, you have about 18 percent of your portfolio in technology already. That should be enough for most people.

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