The rush for hi-tech stocks

By Stephen Williams

Fierce competition between 'old economy' and 'new economy' stocks is shaking the marketplace. 'Old economy' stocks are identified as being older and traditional industries; high street retail and service firms, capital goods' manufacturers, engineering, utilities, energy, building materials and financial services. The 'new economy' stocks are the new technologies, especially those that exploit the internet and the age of wireless communications but it also encompasses microchips, software, biotechnology, fibre-optics and telecoms.

The divergence in performance between these rivals has been widening over the past two years and, in general, technology stocks have outperformed the more traditional industrial stocks. Substantial amounts of institutional and retail investors' funds have been steadily moved from the old economy and re-invested into new economy stocks. There are a variety of reasons for the superior performance of these tech stocks, not least of which is a greater number of retail investors, ignorant of more traditional stock picking rules, buying a certain amount of marketing hype. Another argument for price growth is that hi-tech industries are not energy-intensive and therefore less vulnerable to higher oil prices; while yet another is that any rise in US interest rates would not hurt because new stocks have relatively low debt burdens. Many analysts look at these reasons with a considerable degree of scepticism.

Even so, the past year has seen the tech-rich Nasdaq market in New York climb from lows to highs increasing 100% in value, while the Dow Jones Industrial Average (DJIA), representing 30 US prime blue-chips rose only by 15-20%. However the recent performance of the Nasdaq and other tech indicies has been something of a set-back involving the largest fall in points the Nasdaq has ever experienced and somwewhat reducing that 100% boost to fortunes.

Hi-tech bandwagon

But the hi-tech bandwagon is rolling around the world and some observers estimate the tech-sector represents between 13-16% of total emerging market capitalisation. Some analysts predict that within the next few years, technology may increase its weighting to 25%, thereby overtaking telecoms and financials to become the major overall sector. (The confusion in that, of course, is that many, telecom stocks are now regarded as technology plays.)

In 1999, 37 information technology (IT) companies from the emerging world were listed on the Nasdaq. However, South African tech-stocks are not as overbought as their European or US counterparts. Other South African companies, such as Dimension Data, SA's top IT group, are still seeking listings on the London stock exchange. Datatec, which generates the bulk of its earnings overseas, plans to list Westcon, its American equipment distribution firm on the Nasdaq.

Speculative-tech bubbles

There are obviously speculative punts in some of the new hi-tech companies and these will quickly become unsustainable. Some already have. The valuations of these stocks appear abnormally high and require extremely buoyant rates of earnings growth in the medium-term to justify their exceptional ratings. The price/earnings ratio on the Nasdaq market is now at all-time high of 150, compared to an average of 28 for the DJIA index.

Even the recent downturn in Nasdaq valuations might be seen as a correction but leaves the shares still overvalued. At the current market capitalisation of $83bn, Yahoo (the Internet portal) is worth more than auto-giant General Motors ($57bn). Higher P/E ratios may reflect the market's future expectations of robust corporate earnings but as experience shows, these expectations can be notoriously over-optimistic especially when balanced against stocks with long track records and years of solid profitability.

The hi-tech sector warrants caution and unwise investors who are over-weight in new technology stocks may again receive nasty shocks. The US investment bank, Lehman Brothers, warns that, "People are buying stocks at valuations which have very little to do with rational methodology. Investors value new internet companies as if almost each of them is guaranteed to become a Microsoft." A recent survey by Merrill Lynch found that 75% of new hi-tech companies would never make profits and will eventually disappear either through consolidation or simple failures. It also found that 73% of international fund managers thought the technologies sectors were heading for a crash.

Future winnes and losers

Investors face a formidable task in identifying which new hi-tech stocks will be future winners and losers. Despite short-term volatility, the IT sector, which is becoming an ever larger component of the industrialised world's GDP, retains long-term attractions. New investment in research and development are leading to better products and services, hence improving the outlook for future corporate earnings. Thus a portfolio of mature hi-tech stocks - the likes of Microsoft, Intel, IBM or BT can produce sustained higher returns than heavy-industrial stocks over the medium-to-long term.

However, strategic investors should still maintain an average weighting in old economy stocks because they offer security in the form of regular dividends.

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