Dotcoms are back - but analysts are still cautious

Four years ago, the bubble burst for tech stocks, plunging many into oblivion, says Nick Clayton. Now the survivors are making a slow recovery

After four disastrous years technology stocks have begun to pick up over the past few months, outperforming the rest of the market. This reflects an increasing confidence by investors that the worst excesses of the dotcom boom of the late 1990s have been left behind and the companies that have survived are fundamentally sound.

"Technology stocks have followed a cycle," Paul Munford, fund manager at Cavendish Asset Management, says. "They got grossly overvalued. Then they got grossly undervalued. Now they've lost a bit of that gross undervaluation, but I think tech stocks are still generally undervalued." Mr Munford runs the Cavendish Opportunities Fund, which moves between sectors according to market conditions. He did not invest in technology stocks during the dotcom boom.

Now he believes the crash in the price of technology stocks offers investment opportunities in the surviving companies. "Part of the reason many companies came unstuck was because they built their business plans on the basis that they could finance their future commitments by issuing shares at the inflated levels the markets had reached," he says. "Then companies got so overvalued at the top of the market that stockbroker forecasts had to be pretty extravagant to justify those prices."

As share prices fell, not only did companies find it harder to borrow, but they also reduced their forecasts of future growth and profits. "If the market stays flat you'll get companies achieving their forecasts," Mr Munford says. "But if the economy picks up they'll be in a position to exceed those expectations." That should mean large rises in their share prices.

In the past few months, he says, there have been signs that demand is picking up in the technology sector. This is already having an impact on some technology companies, such as Intec Telecom, which reported profits of £5.4m, almost twice the original market estimate of £2.8m. Its shares have risen from 14p in May to 69p this week after being as high as 77p. But they were worth more than 700p at their peak in 2000.

Many telecoms-related businesses are reporting better-than-expected figures. The share price of mobile phone retailer Carphone Warehouse has soared and and they reported a sales boom before Christmas. But at 139p the shares are still well below the 200p at which they were floated in 2000.

Britain's second-largest company, Vodafone, announced last week that it had increased its customer numbers by more than 4 per cent in the last quarter of 2003. It has also announced customer trials using its third-generation mobile phone network in the UK.

Although Hutchison 3G has been selling subscriptions since last March, Vodafone will be the first of the established telecoms companies to offer the new high-speed service. This is good news for manufacturers, who will benefit from the increased sales of the new 3G handsets.

Another gainer will be British microchip specialist ARM Holdings, which provides processors for around 70 per cent of the world's mobile phones. The results announced last Wednesday were weak for the year as a whole, but the last quarter showed a real improvement and forecasts for the coming year are good enough for the company to start paying dividends for the first time. The biggest problem it faces is that chips are generally paid for in dollars, the weakness of which means it has to sell more of its designs for the same return in pounds.

Not everybody is as optimistic about growth forecasts as ARM. The respected City technology analyst Richard Holway says: "I would almost stake my reputation on us being in a mini-bubble and although it will clearly go on for one or two quarters, we believe another correction will occur this year."

Mr Munford is also slightly cautious, pointing out that although technology companies were reporting increased purchasing by large companies in the last three months of 2003, this could just be a spending rush before the end of their accounting year.

"It remains to be seen whether this increased spending is a trend. I suspect that once one company starts buying technology the competition will start doing the same, and it will become a rolling trend." While fund managers such as Mr Munford are looking at existing shares, others are looking further ahead.

Venture capitalists try to invest in young businesses before they enter their initial growth phase. They hope to make a profit when the company is sold or floats on the stock market. It is a risky business, but one that can show huge returns if their predictions are right.

Bundeep Singh-Rangar, joint founder of Ariadne Capital, expects future successes to come from companies supplying software services on demand over the internet; software that will enable the testing of programs developed simultaneously in several countries and data management and programs which use the systems developed for the internet.

These are highly specialised areas, which will put off many investors who are wary about putting money into something they do not understand. He says: "You can mitigate that lack of understanding if you're using the software yourself or if you work for a corporate that's using it. The other ways are to look at who else is using the software. Are big companies taking advantage of it? Then look at who's investing in it."

Ray Burgum, of the stockbroker WH Ireland, says: "As with all investments, when looking at individual companies, investors should spend time finding out as much as they can about the company.

"Be it an established business or a new company aimed at new markets, a good management team, strong intellectual property rights, a sound financial base and the potential for its market to grow are all key to reducing the chances of making a poor investment. This can be difficult and time consuming for the individual investor, but the internet can get you a long way."

Mr Munford says: "Go for companies with a good business plan, a strong balance sheet and reliable management in an area of the marketplace that's offering growth. I'll pick a technology stock if I think it's got the capability to double over a year. That doesn't mean it will double in value, but at least it has the potential."

INVESTING IN TECH STOCKS

As with all investments, the greater the risk, the greater the return and the greater potential for losses. The technology sector is risky. In 2000, even long-established corporations such as Marconi, BT and Cable & Wireless were hammered too.

* Spread risk by holding a portfolio of shares in several companies in different sectors. Some may fail, but technology stocks can show spectacular gains and one of these can more than make up for several disappointments.

* The internet offers the small private investor access to information previously confined to professionals. Try websites such as Yahoo, MSN, Motley Fool and MoneyExtra. Some have bulletin boards where investors discuss various shares. These can be a valuable source of information from experts. But they are also inclined to get over-excited about hype from the companies.

* After you have selected a company, the cheapest way of buying shares is usually online on an "execution only" basis, without advice from a stockbroker. Websites, including some linked to well-known financial institutions, offer this service.

* The alternative to personally selecting all the stocks is to buy into a technology investment fund. Although the stocks will be chosen by a fund manager, it is still worth doing your own research because, with dozens of products available, you can choose the one which comes closest to your ideal portfolio. Just watch out for the level of fees which can eat a big chunk out of your profits or add to your losses. The Trustnet and Morningstar websites provide valuable comparisons.

* These investment products can be bought from an independent financial adviser or, often more cheaply, from an online funds supermarket such as fundsdirect or one attached to a bank or building society.

CONTACTS

* Digital Look: www.digitallook.com

* Hemscott.net: www.hemscott.co.uk

* Investment Management Association: www.investmentuk.org

* Morningstar: www.morningstar.co.uk

* Trustnet: www.trustnet.com