Technology
KAREN GIBBS: The Nasdaq's run this past year seems to be déjà vu all over again. Since January of 2002, the index is up an astounding 54 percent, so another bursting of the bubble must be just around the corner, right? The signs are everywhere. Just this week Intel admitted corporate technology sales are still just limping along.
But this isn't 1999 and one investor's bubble may be another's golden opportunity. After all, many of the tech and dot.com survivors are still standing, and for a reason: They sell things that people actually want to buy. The fittest have survived.
But finding those those survivors can be a tall order, something Doug Foreman of TCW Galileo Aggressive Growth and Tara Hedlund of Turner New Enterprise excel at. Vadim Zlotnikov, chief market strategist at Sanford Bernstein, takes the big picture view, and it's hard to talk about tech without looking at the market as a whole. Just this week the Nasdaq turned around and was up for the week by nearly 18 points. The Dow rose more than 11, and the S&P picked up almost 12.
So Vadim, what does the big picture look like? The jobs picture was bleak, interest rates look stable for the near term at least, and the dollar continues to fall. Is that good or bad for tech?
VADIM ZLOTNIKOV: Well, it depends which part. Last year was a year of anticipation. Companies basically did not really have to deliver. As long as they showed some progress, the stocks went up. During this year, they're going to have to deliver against fairly aggressive expectations, particularly as the year progresses. And the key to this year, rather than the employment growth or anything else, will be corporate spending. Will corporations -- which have a tremendous amount of cash and (are) generating a lot of cash -- go back and start to spend on technology?
GIBBS: We do seem to see a little stumbling here on the business spending, and a lot of it is just for replacement. What is going to be the key to get them to really aggressively start spending?
ZLOTNIKOV: In all the surveys we've done, the thing that corporations are looking for at this point is pricing power for their products, any evidence of reflation. Once they have that evidence, once they see some organic growth, they are looking forward to deploying new software applications. But as you correctly pointed out, through today the spending has been primarily replacement, and that's not really driving much growth.
GIBBS: Doug, Vadim mentioned expectations, and it does appear that we are very optimistic about the outlook for tech. What's different now than it was in 1999?
DOUG FOREMAN: We believe that the conditions that were in place for a fundamental meltdown that we saw back in '99 and '00 are nowhere near present today. So we don't think the risk today is anywhere near what it was in '00, despite the fact that many of these stock prices have recovered, as you pointed out, over the last year.
GIBBS: But, Doug, looking at valuations, doesn't that kind of suggest a little exuberance about forward growth?
FOREMAN: Yes, they're not as cheap as they were 15 months ago. There's no question about that. But we think many of these companies will at least hold their valuation and grow in line with their revenue growth, which it can be and is very significant over the next two to three years.
GIBBS: Tara, what do you see as the most exciting innovation in the technology picture coming down the road now?
HEDLUND: In technology there's quite a few emerging themes that we like, such as RFID, which stands for Radio Frequency Identification, which is using a semiconductor chip to wirelessly track items, and a main driver there is Wal-Mart. Wal-Mart has required their top 100 vendors to be RFID compliant by January 1, 2005. It reduces costs in their warehouse and it also improves their tracking of inventory and reduces spoilage and error and misplaced inventory. So it's a very important driver for Wal-Mart, and we think Wal-Mart, as one of the largest consumer plays here, will drive RFID to be a very big technology theme in the next few years. One of our main picks in that area to capitalize on that theme is Zebra Technologies. And Zebra Technologies currently makes bar code printers.
We also like themes in VoiceOver IP, which is voiceover Internet protocol. We also like the open source movement, which is Linux-related.
GIBBS: And open source is basically free competition for Microsoft's software. How do companies make money giving stuff away for free?
HEDLUND: Well, the two main distributors of Linux are Red Hat and Novell, and what they do is provide a service. They package this free software and they provide the maintenance and the updates for companies, and they provide that sales service to enterprise corporations.
GIBBS: Doug, what about some of the Internet companies? Do you see any value there for investors and consumers?
FOREMAN: Well, I think the Internet has continued to be probably the single biggest event in my lifetime in terms of a technology revolution. The stocks obviously have had their, more than their fair share of ups and downs. But the survivors in this space and what I would call the real companies in this space -- the eBays, Yahoos, the Amazons, InterActiveCorp -- which are the companies we tend to own, are not only survivors but they have tremendous business models, tremendous free cash flow characteristics, and we believe tremendous growth opportunities going forward. The stocks aren't as cheap as they were 15 months ago, which I would argue strongly were ridiculously cheap, but they're still, I think, poised to grow in line with their overall revenue growth going forward from here. And that's still very significant and higher than what you can get in most businesses.
GIBBS: Vadim, what would get you to either unload your tech holdings or add more? What would you need to see coming down the road?
ZLOTNIKOV: Right now if you look at the expectations, particularly going all the way into '05, analysts expect technology companies' profitability to be higher than it's been in 50 years. In other words, companies are expected to generate profit margins that are higher than they've ever been before. In order to get there, you really need to see the third leg of demand kick in, so as to give companies some pricing power. So really looking at the enterprise spending, particularly for new software applications, is absolutely key. I would also be looking at the semiconductor commodity spot prices, which can often give you an early indication as to whether the demand for the end equipment is materializing. And finally continuing to look at the incremental profitability of the companies, are they really generating the type of incremental margins that the market is now expecting?
GIBBS: Taking those variables that you've mentioned, what are your top stock picks?
ZLOTNIKOV: Right now we like three stocks. Applied Materials is the first choice. It's a semiconductor capital equipment company. It's a leader. People forget that even if the demand is not as robust, a lot of the semiconductor cycle could persist because of the significant underinvestment that has taken place in semiconductors over the last three years. And I believe spending on equipment could be quite strong for the next two to three years.
The second one is International Paper. It's not exactly a technology company, but it's benefited from some of the same trends of under-investment and capacity and is seeing improvement pricing and improving utilization.
And the third one is Medtronic, which is a medical devices company which should see mid-teens growth over the next two to three years which is probably in line with the expected appreciation.
GIBBS: Tara, you heard the stock suggestions that they've mentioned. You had some very interesting ones in terms of this voice technology and Internet protocol. What are some of the other companies you're looking at?
HEDLUND: We're very favorable on Juniper Networks, it's one of our top picks there. We also like Comverse Technology, which is involved in the wireless space. It provides software for wireless carrier providers and a new platform that they have, a new product is called InSight Platform, so a consumer, a subscriber, when using their voicemail on their cell phone doesn't need to necessarily dial in to hear all of their voicemail messages. They can actually look at the callers on their screen. So it's more of an IP-enabled voicemail service. And we think that carriers have been underspending in that space in the past few years, and we look for Comverse Technology to see new orders in 2004 related to that.
GIBBS: Vadim, if you leave tech, where are you putting your money?
ZLOTNIKOV: Health care and energy. Those are the two areas where I think it could continue to outperform the market, the third one being technology.
GIBBS: Vadim Zlotnikov, Doug Foreman, and Tara Hedlund, thank you very much for joining us.
HEDLUND: Thank you.
FOREMAN: Thank you.
Retirement
COLVIN: Whether you're in tech stocks or any other stocks, will they perform well enough for you to afford retirement? That's a huge question as millions of baby boomers approach that fateful day, and it's a hot political issue after Alan Greenspan said the unsayable, that Social Security benefits will have to be cut and the retirement age extended. So what are you supposed to do now to assure yourself a decent retirement? Michael Farr is president of Farr Miller & Washington, an investment firm, and he's a regular contributor to Wall $treet Week with FORTUNE.
Michael, I'm guessing that if you're 60 years old right now, your Social Security benefits are probably pretty safe. If you're 40, how should you be thinking about this?
FARR: I think if you're 40, Geoff, you better have a backup plan. You better have some alternative to support you when you retire, because in 2018 it looks like there's going to be more money going out of the Social Security system to retirees than it takes in.
COLVIN: And at that point there will still be millions and millions of baby boomers yet to retire.
FARR: Yes. As this large part of the population begins to retire, we're going to see, starting in 2000, I think in 2013 the average baby boomer starts to turn 65, and that will then extend so that by the year 2050, we're going to see a huge deficit under current assumptions for the payout of Social Security benefits.
COLVIN: You recently visited a family that was making some pretty interesting choices about how to prepare for retirement. Let's take a look.
RANDALL BEDNAR: I have a daughter who's 16 and I have a son who's 12 and another son who's 5, and I have a lovely wife. I've been married for 18 years now. I'm 43 years old. I'm a fourth grade teacher at Landon School. I do a fair amount of coaching for the school, which is additional income. I also on the side sometimes do some tutoring, which can also act as generating extra revenue also.
FARR: That's a lot to handle. Now does your wife also work?
BEDNAR: No. She's a stay-at-home mom.
FARR: So, on your salary, teaching, you support your family and three children. How is that? Easy? Hard? Manageable?
BEDNAR: At times it can be very difficult, especially on the horizon with my daughter thinking about college and trying to keep our head above water, it's not the easiest of things to do.
FARR: In 20 or 22 years, you'll be 65, but if Mr. Greenspan has his way, given his testimony the other day, that's probably going to be longer than 65. Tell me, though, because he was addressing Social Security, Social Security, as a part of your retirement plan, have you thought about the income you're going to have when you retire?
BEDNAR: Social Security is one form of retirement, but with the projected shortfalls and less revenue coming in and more money going out to benefits, it's something certainly that I'm weighing very, very heavily. That's why I've chosen the alternatives, because I'm not quite certain that the money is going to be there when it comes time for me to take it out. I'm an active contributor to my pension fund at the school, and I also have a universal policy that is wrapped around mutual funds that I'm also an active contributor to also.
FARR: A universal life insurance policy.
BEDNAR: That's correct.
FARR: Right. And within that universal life insurance policy, there are mutual funds.
BEDNAR: That's correct.
FARR: And in those mutual funds, do you usually favor the equity mutual funds or the fixed income funds?
BEDNAR: I'm 100 percent equity.
FARR: 100 percent equity.
BEDNAR: That's correct.
FARR: Okay. Now I'm going to go ahead and guess that that's because equities historically have a higher rate of return than fixed income, than bond instruments. Is that why you're there, or do you just like them better?
BEDNAR: No, absolutely, Michael, we've thought about this a long time, and we feel like we have to handle our retirement money completely different than we handle all our other money. And knowing that in the equity market the greatest resource that one has it time, okay, and I'm still 20 years away from retiring, we would like to place, you know, per se all our eggs in one basket, knowing that if time is on your side that the equity market will return more on average than any fixed income. So for the time being that we don't need the money in the next 5, 10, 15 years, we'll continue to invest in the equity market.
FARR: Given the choice of paying Social Security the way you do now or paying it into a private fund, which would you choose?
BEDNAR: Personally, I would like to put it into a private fund. I would like to have some ownership over it and some say in how the money that I've earned is going to be used later on in life.
FARR: And know that that money will be under your name and somehow be there for you someday in the future.
BEDNAR: Absolutely. I think it would be more reassuring to know that, that you have some type of control or power over how the money is going to be there when you need it.
COLVIN: Michael, they're 100 percent in equities. Is that wise do you think?
FARR: At their age and given their circumstance, yes, I think it's acceptable, because their time horizon is long enough. Ibbotson's has done a study that shows that over a 20-year period, a high quality stock portfolio is no more volatile than a high quality bond portfolio, and yet if the rate of return is historically superior in a high quality stock portfolio, someone, a family in this position is going to need the best return they can get in order to be able to retire.
COLVIN: Now they are big savers, and that's great. They're putting away a lot of their income. I've got to think that this has meant some sacrifices for them. Has it?
FARR: No question. I asked them about that, and they assured me that at times it was very difficult to make those sacrifices. They go on a one-week vacation to the beach every year. They do not buy anything that would look extravagant, and they stick very close to a budget.
COLVIN: We live in a society that doesn't really celebrate thrift a lot these days. Now they're doing the right thing by saving a lot, but do you get the feeling that maybe they feel a little bit out of step with the times, and is that tough on them?
FARR: No question, and particularly in Bethesda, Maryland, it's a very affluent area, I think it is hard not to look like you're keeping up with the Joneses. I think that the Bednars and investors like them, and if there were more Americans who invested like them, we would all be much better off in our retirements and we would be a stronger country economically. And I think the Bednars' day of reward and celebration is coming, given the good moves they're making today.
COLVIN: It sure sounds that way. Now he said that he would like to have all of his Social Security contributions under his own control. Now he is a savvy, diligent investor. As a policy recommendation, does that sound right to you?
FARR: It frankly worries me because there are those people out there without the sophistication, many Americans without the sophistication to make those sorts of decisions for themselves. President Clinton had a plan whereby there would be sort of a Social Security mutual fund that would be administered and somehow managed by the government or a government contractor, that would somehow manage the risk within those portfolios. That seems, I'm not often, I've never said I don't think that I prefer the Clinton plan too often, but on this case I really do. I think that perhaps something that would take the responsibility away from the individual investor and yet allow that investor to benefit from the higher historical rate of return would be a good thing.
COLVIN: It's a huge topic that we will be talking about a lot more through this election year and even beyond. Michael Farr, thank you.
FARR: Thank you.
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