Six tech stocks set for big gains

At the beginning of this year, technology, and US technology in particular, really seemed the place to be. The sector rose 6.3% in the first two weeks of the year more than it did in all of 2004 and 2005 combined.

And within that rise, says Katherine Griffiths in The Independent, there were some "soaraway" performers. Investors, thrilled by the 14 million iPods that flew off the shelves in the run up to Christmas, poured into Apple and others, and, noting the way in which Google, Yahoo and Ebay have become part of our lives, bid their shares up to levels not seen for several years. Indeed, for the first few weeks of January it seemed that the tech bulls were finally going to see a year go their way.

Not any more. Due to disappointing results and warnings of slower earnings, the sector's big names have taken a tumble. Apple said last week that it had seen a 65% leap in revenues year on year in the three months to 31 December, yet its shares fell more than 3% as investors took fright over suggestions there may be a "pause" in demand. At the same time, shares in Yahoo and Ebay have faltered in the wake of disappointing results and subdued future forecasts. At one point, Yahoo shares were down 12% from recent highs.

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So what's going on? Some suggest the jitters in the US might have been exaggerated by the sell off in Tokyo following the Livedoor scandal. But Livedoor, while interesting, is a small and speculative firm, the activities of which have no bearing on the state of the wider market.

Instead, says Richard Waters in the FT, the sell off is the result of over-optimistic expectations not being met. The fact is that the boom in corporate profits may be running out of steam and not just in the tech sector.

Does this mean that investors should get out of the sector altogether? No, says Joseph Battipaglia of Ryan, Beck & Co in BusinessWeek. Technology firms tend to be big beneficiaries of capital expenditure, and after some years of retrenchment in this area, as firms concentrated on producing cash and profits, capital expenditure is likely to be the "power" behind the economy in 2006 and 2007. Business purchasing is currently rising at an annualised rate of 9% and "should accelerate" as the replacement cycle takes hold; expect the profits of the big tech stocks to do the same.

Jon Markman, writing on MoneyCentral.com, is more cautious. The long awaited "convergence" between consumer and business-related electronics is finally underway, he says, and it is true that this has spurred a "new wave" of earnings growth and multiple expansion.

But that doesn't mean you should be investing indiscriminately. Many firms particularly those in consumer electronics and web advertising are overpriced, so anyone investing should look instead at "neglected names" in sub-sectors, such as hard-disk storage and semiconductors.

You certainly can't treat the sector as one, agrees Robert Cyran on Breakingviews.com. The once "walking dead", such as Hewlett-Packard and AMD, have been stealing a march on rivals with improved management and development, so the 50% rise in their shares over the last year makes sense.

But the likes of Apple and Motorola could soon be hoist on their own petard. Both achieved success by hitting on a rich vein of popular products in an environment of shortening product cycles. However, no one is exempt from a period on the wrong side of "fickle trends", and just like Japanese rival Sony, they could all too soon find themselves abandoned by their public.

The six best stocks in a struggling sector

Joseph Battipaglia of Ryan, Beck & Co expects corporate spending on technology to continue to rise, he says in BusinessWeek. If he's right, software companies such as Microsoft (MSF, 1,476p) "stand to benefit". In the mobile phone area, he points to Motorola (MOT, 1,258p) it has "dramatic" new products and Palm (PAL, 1,929p). In networking and internet telephony, he tips Cisco (CSC, 1,024p) to surprise after a long period of disappointing performance.

Jon Markman of MoneyCentral.com is looking more towards the "red-hot" area of hard-disk storage for personal computers, MP3 players and networks. Seagate Technology (STX:US, $26.39) bought industry rival Maxtor last December, which helped remove the threat of price wars and overcapacity both major problems for the industry in the past. Seagate is a "terrific innovator" and bigger disk drives for computers and personal media players will start to come through later this year. Now on a p/e of 15, the stock should, he says, trade over 30% higher by the end of the year.

He also likes ON Semiconductor (ONNN:US, $7.27), which makes about 25,000 types of integrated circuits for makers of cars, cell phones, gaming consoles and media players. With declining inventories and demand on the rise, ON could earn 65 cents a share in 2007. That, says Markman, means the share price could almost double in the next 12 to 18 months.