|  Duff McDonald is Executive Editor in charge of public market coverage for Red Herring Communications, both in print and on RedHerring.com. He is also New York Bureau Chief for the company's editorial operations. Business technology Introduction We at Red Herring are devout followers of venture capital, of the great liquidity event known as the IPO, and also of the democracy of the public equity markets. We are drawn to companies that change the way we live - at work, at home, or somewhere in between. Find one, and odds are good that it's a technology or telecommunications company. Once considered narrow, monolithic sectors, technology and communications together made up nearly a quarter of the overall market capitalization of the S&P 500 in mid-2001. Combined, those companies had trailing 12-month revenues of $1 trillion. Even after a tumultuous year, 8 of the 20 most highly capitalized companies trading on U.S. exchanges were heroes of the networked era - including Microsoft, Intel, AOL Time Warner, IBM, Verizon Communications, and Cisco Systems. And 8 of the top 20 performing stocks over the past five years were technology companies. The future could bring a similar imbalance: as a group , technology and telecommunications companies are projected to post annual earnings growth of more than 20 percent over the next several years - more than half again as much as any other sector. But that number even includes giants like IBM that lumber along churning out earnings growth rates in the high single digits and low teens. The majority of companies expected to post long- term annual earnings growth of 100 percent or more are technology, healthcare, or telecommunications companies. Of course, these stocks tend to be expensive. And volatile. Catch the swing at the wrong time - as many have done recently - and you've got big losses on your hands. Follow strict principles in investment process, though, and you have the opportunity to profit handsomely. Our principles follow. -
We believe in disruption. Change, as John F. Kennedy so succinctly put it, is good. New technologies driving new functionality in our PCs, networks, our cell phones, our automobiles, and even our bodies are the lifeblood of the Red Herring ethos. And we want to invest in the companies driving those changes. At the right price, we like software makers like BEA Systems, i2 Technologies, Mercury Interactive, or Veritas Software; biotechnology companies like Illumina; and fledgling energy companies like Ballard Power Systems. That doesn't necessarily mean that we're focused on Silicon Valley-like upstarts to the exclusion of all else. Texas Instruments, for example, pulled off one of the greatest about-faces in corporate history when it transformed itself from a sluggish maker of pocket calculators into the world's leading manufacturer of digital signal processors for cellular phones. -
But we also believe in market power. Despite the market's recent punishment of technology kingpins like Cisco Systems and EMC, investors would do themselves a grave disservice to forget about the big guys and focus exclusively on the next hot stock. Technology, by its very nature, lends itself to the creation of monopolies. That, in turn , translates into the ability to set the standards, and to reap outrageous profit margins. Legal woes aside, Microsoft's gross margins of 80 to 90 percent are still to die for. Not surprisingly, the stocks of companies in this position - colloquially referred to as gorillas - tend to be expensive. But unless we see serious trouble on the horizon, we tend to be inclined to pay a premium for leadership. Other candidates in this category include database leader Oracle, wireless vanguard Nokia, and semiconductor equipment maker Applied Materials. -
We believe in convergence. Technology in and of itself contains endless investment opportunities - PCs, cell phones, internet, whatever. But when technology meets something like health care, things get really interesting. By their very nature, investments in companies that are trying to retool the human body can be quite speculative . But they can also be among the most rewarding : companies like Immunex, IDEC Pharmaceuticals, and MedImmune all delivered returns of more than 1,500 percent over the past five years. Slightly less profound, but still offering awesome investment possibilities, is the convergence of technology and entertainment. Technology and finance also make a fine pair. -
We believe in diversification. If there's anything that technology investors like more than originality, it's a good old-fashioned bandwagon. In recent years, we've seen B2C, B2B, P2P, Internet infrastructure, optics and others being the drivers of said bandwagon. While we're not one to argue with great ideas, it's important to withstand getting hypnotized by the latest buzzword and to diversify technology investments. Taking a step back, it's also important to diversify outside of technology itself, if only because the sector's stocks continue to move in a loose unison . -
We believe in being reasonable. When investors lost all sense of rationality at the height of the internet bubble and proclaimed the importance of profits an anachronistic concept, we voiced our dissent. It's okay to forsake profits to establish one's business, but one's business should still be about making profits. Companies that merely demonstrate an ability to spend money at investors' expense are not on our short list of purchase candidates As reasonable investors, we also place less importance on the results of a single quarter than momentum investors do. If a company misses earnings expectations for reasons other than extreme ineptitude, we're inclined to consider purchasing a battered-down stock. Likewise, one quarter of outperformance doesn't justify the opposite treatment, and we see extreme optimism as a chance to take profits. -
We believe in a medium-term perspective. We try to take a longer-term perspective on the purchase of a stock than whether or not next week's press release will be positive or negative. That said, it's important to remember that technology is about change ”and even once-omnipotent companies can be yesterday 's news if they don't keep innovation as their mantra (think Novell or Corel). For that reason, we are fans of the medium-term, or a two- to five-year horizon, a span in which we feel we can comfortably understand the possibilities. In the shorter-term, stock market movement is just noise; the shape of things ten years from now is just too difficult to contemplate. So while we advocate a buy-and-hold approach, we're not afraid to let go. That said, we believe that technology is showing the way to the future, and technology stocks should do the same in a portfolio. www.redherring.com 'When bears rule the street, it pays to own things that pay you to own them. This includes stocks that pay high dividends , preferred stocks, REITS, convertible bonds , and balanced mutual funds that own a mixture of the above assets. If it takes years for stock prices to rise, you might as well get some return while you wait.' ”John Rothchild |  |
