The Economy And Technology SpendingWhy Do We Still Believe the Technology Sector Is By Sam Ouyang For technology investors, the past two years have been full of pain and frustration. It is torturing to watch the NASDAQ drop from 5000 to 1200, while investors' darlings such as Ciena, Juniper, and Amazon lose more than 80% of their market value. It is frustrating to see rallies kept fizzling into devastating plunges and to read of bankruptcy stories, waves of layoffs, and scandals almost daily. With the market plunge, the gloomy IT outlook, continual earning misses, and Wall Street's other troubles, it's no wonder investors are losing interest and confidence. Over the past year, ridiculing high-tech companies has become a popular sport, and many say IT's revolutionary impact is overestimated. Plenty claim the IT boom was just hype and a bubble, and some go as far as to claim that Internet stocks were conspiracies of analysts and other Wall Street and With so much talk about the overcapacity in the technology sector, and corporations' shrinking IT budgets, it is understandable that investors are scared and suspicious of the potentials in the sector at its core. How Important is the Technology Sector to Our Economy? Despite so many negative reports about technology and the new economy, the information sector has become a very important part of the economy. While currently IT-producing industries represent only 7% of all businesses, they accounted for roughly 28% of overall real economic growth between 1996-2000. More than 15 percent of our GDP already comes from the New Economy. As a matter of fact, Software, IT, and communications equipment provided a massive boost to our national economy, contributing more than 20 percent of output growth in the latter half of the '90s. And these emerging IT industries are unstoppably on track to represent more than 25% of the U.S. GDP and 50%+ of stock market capitalization by 2005. Accept it or not, the technology sector has become a significant part and the most active part of the economy. More importantly, technology has produced far-fetched impacts on the economy and the traditional industries. One of them is that the technology sector has boosted productivity. Starting in 1996, American productivity growth exploded to 2.5% per year, up from 1.4% per year between 1975 and 1995. IT products and IT-producing industries contributed roughly two-thirds of this extraordinary growth. And it's worth noting that this growth endures. During each of the previous eight recessions, productivity growth turned negative when the economy contracted. By contrast, during the economic downturn of 2001, productivity growth remained robust at about 2%, jumping 5.2% in the 4th quarter of 2001(of course, part of the productivity rise should be attributed to layoffs of workers in that period). A Labor Department report in May showed that productivity--output per hour worked--grew 8.6 percent in the first quarter and recorded its biggest increase in nearly 19 years. This is critical because the IT also lowers inflation and makes economic growth and bull markets longer and more durable. Falling IT prices have directly pulled down average inflation by 0.5 percentage points a year. From 1989 to 2000, inflation in IT-intensive industries was just 1.3% per year on average, compared with 3% in less-IT intensive industries. In addition, by raising their productivity, IT is lowering inflation of other industries. This makes the economic growth more durable and sustainable. In other words, due to the structural changed caused by the technology sector, future bull markets may last longer before the Fed to step in to increase interest rates to check inflation. What Has the Technology Sector Gone Through in the Past Two Years? What the technology sector experienced a few years ago was a well-known dot.com bubble. Maybe you still remember the dot.com craze in1999 and early 2000. Then many dot.coms which did not have any sales, let alone profits, but only had business plans were able to get millions of dollars from those get-rich-quickly venture capitalists. For those dot.coms, getting "eyeballs" was the most important business goal. To achieve that, those dot.coms bought a great number of routers, switches and servers to have a great amount of bandwidth. When the bubble burst, those dot.coms had to sell their routers and switches at a huge discount. This inevitably depressed the prices of servers, routers and switches and hurt their manufacturers such as Cisco, Sun Microsystem and Juniper, etc. What the technology sector has gone through is basically consolidation. To put it in historical perspective, it is quite normal. Whenever a new technology and a new industry emerge, there is some kind of speculative investment boom, though with different magnitude. The enormous promise of new technologies and new industries lures investment and enriches the first-wave investors. Their get-rich stories then direct more investment into these new technologies and new industries and hence make the area overcrowded and the competition in these industries fiercer. The investment boom inevitably drives down the rate of return on investment (either on public equity or private equity market) and hence drive many companies out of business, which are weak technologically and financially. In the last century, railroad, automobile, telephone, and personal computers all experienced this kind of boom-bust cycle. What is going on in the technology sector is the same. Not long ago, thanks to a great amount of speculative investment, many technology companies came to market in a "pre-IPO stage." In other words, they were not ready for prime time, lacking the traditional qualifications for an initial public offering. They were companies that, in the past, would have been financed by friends and relatives of the entrepreneurs who started them and by deep-pocketed venture capital firms. But the NASDAQ was gracious enough to allow early-stage companies with little or no profits to list shares. The result was that the technology sector became too crowded. Still remember how many wireless service providers and Internet service providers existed three years ago? What has happened for the past two years is a process of purging and consolidation in the technology sector. Those companies that did not have good management, well-protected intellectual properties, good products, and solid balance sheets have been weeded out. The market is selecting the fittest for survival. This process is certainly painful because a lot of businesses go under water and a lot of investments become worthless. The good news is that after this purging process, what is left are the strongest and healthiest technology firms and these firms have great likelihood to become the most successful technology players in the long run. The Technology Sector is Not As Bad As Is Portrayed By The Media We have heard too many stories about the sorry states in the technology sector. Unfortunately, most of them are misleading. Take the IT investment as an example. According to the Department of Commerce, with prices falling, the plunge in IT producers' revenues gives misleading picture of the role that IT plays in the overall Companies slowed down investment in IT initiatives in 2001, but this appears to be catching up to them now, with fewer executives expressing confidence that they are ahead of their competitors in terms of the company's use of technology. According to Darwin Magazine, in January, 42% of executives agreed that 12 months ago their company was ahead of its competitors in terms of its use of technology to improve business. When they were asked this question in December 2001, only one-quarter (24%) believed that their organization was ahead. A greater percentage of executives surveyed (43%) felt their company would be ahead of its competitors in terms of its use of technology 12 months from then. That's why companies' CIOs have longer "to-buy" lists and most firms indicate that they would increase their IT spending from their 2001 levels. Looking forward, since many types of IT equipment is replaced every three to four years, the IT replacement cycle is going to kick in this year and next year for the companies to maintain their net IT capital stock. All of these indicate that the slowdown in information technology investment will soon end. Why Does The Technology Sector Still have a lot of Potential? Despite a lot of talk about new economy, broadband revolution, and wireless revolution, there is still only a small portion of enterprises and consumers who have just started feeling the real impacts of these new technologies. Using broadband as an example, as of Online business is another interesting example. It is widely known that networking technologies are not only enablers of new sales and purchasing channels and help firms to improve their competitiveness. A recent survey shows that on the manufacturing side, only 19.2 percent of the firms provide online support to customers and 7.1 percent engaged in online bidding; and on the sales side, only 11.1 percent firms received online payment and 19.2 percent provide sales support, and on the buying side, only 8.6 percent made online payments and 7.1 percent engaged in online bidding. These data suggest that firms are still in early stage of exploiting network technologies. Although there are many reasons for this, the truth is that the potential for networking technologies will be great and will be exploited in the next few years. Furthermore, despite some pessimism about the technology sector, companies are still counting on IT to help improve the bottom line and to pull ahead of competitors more so than before. According to a survey conducted by Darwin Magazine, one third of the surveyed firms said that IT was important or extremely important to the company's ability to meet its financial objectives over the past 12 months. Looking forward, 55% of those surveyed said IT would be important or extremely important in the next 12 months. Additionally, the majority (81%) of executives in the survey said they view their organization's IT as a value center, meaning that IT was a strategic investment critical to growing revenue and differentiating the company from its competitors. This is an increase of 5% from the December poll. The remaining 19% said they viewed IT as a cost center - an overhead expense necessary to maintain the company's information and systems. The point is clear: IT's real impacts on business are just being felt and businesses are still anxious to use IT to improve their efficiency and competitiveness. This means the potential the technology sector provides is still enormous. Why Is the Technology Sector Still the Best Place for Investment? The most important force driving stocks' performance is companies' profits. In other words, to have superior long-term performance in a stock, the stock must have exceptional earning performance for a long time. Given the potentials the technology sector provides and the early stage of the application of information technologies to businesses, the dynamic technology sector is the only area in which companies can constantly provide exponential revenue growth and earning growth for a long period in the future. Although history may not be the perfect forecast of the future, looking at the performance of investment in technology companies in the past 10 years, we can still appreciate how attractive the technology sector has been and will be for investors. A study shows that in the 1991-2001 period which covers two bears markets and one long bull market, among the 20 stocks whose share prices increased the most for that period, fourteen were in high technology, and nearly all of them benefiting from the Information technology boom. No. 1 on the list was Dell Computer Corp., whose sales have increased from less than $1 billion to more than $30 billion in a decade, in large part because of the firm's agility in selling online and the demand of consumers and businesses for products that link to the Internet. No. 2 Emulex makes sophisticated connectors that speed the storage of electronic data. No. 8 Cisco Systems Inc. is the prime manufacturer of Internet infrastructure. Other well-known tech names on the list include EMC Corp. (4), Applied Materials Inc. (5), Oracle Corp. (6) and Maxim Integrated Products (10). The performance of the 20 stocks was astronomical. Dell's stock price, for example, increased by 7,890 percent. In other words, an investment of $1,000 grew to $79,900 in 10 years. Even the No. 19 stock, Intel Corp., rose 1,668 percent -- not including dividends. Undoubtedly technology stocks also rally most when the market rebounds. As the following table shows, in the September/2001 - January/2002 rally, compared to other stocks, technology stocks in the Hager Tech Portfolio with solid business models and balance sheets rallied very impressively. On average, the Hager tech stocks gained by 49%. From Besides the great market potentials the technology sector provides, the other very important reason for investing in technology sector now is that the risk for losing money in the technology sector is much smaller. After the consolidation process and after many weak companies are purged from the market, the technology sector is becoming a much better and safer place for investment. The market potential the technology sector has becomes realistic and clear. The technology sector is becoming less crowded. Remaining companies are stronger technologically and financially and have much better chances to succeed. If buying technology stocks three or four years ago was speculation, now it is real investment because you are investing in very healthy technology companies which have great chances to become tomorrow's Microsoft, Intel or Cisco. Performance of Hager Tech Stocks in the Period of
Note: In the last market rally from Sept. 30th 2001 to Dec. 11th, 2001, the Hager Tech stocks outperformed the Dow by 635% and outperformed NASDAQ by 156%. Since then, the market has been experiencing a correction. But given the strong fundamentals of the companies in the Hager Portfolio, I believe that these stocks will have similar potentials to rally in the next upward move.
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