Consider a Barbell Strategy in Tech
This structure proposes a blend of highest quality tech names and speculative holdings.
In most ways, the landscape in Tech today is the antithesis of what we saw in March of 2000. Bubble valuations have been replaced with numbers of best-of-breed stocks with PEs below the market (Hewlett-Packard (HPQ), Apple (AAPL), Cisco (CSCO), Microsoft (MSFT), and so forth), record cash balances which further serve to further compress valuation ratios and various PEG ratios sit below those seen in 1997. Further, in 2000 many of the perceived negatives were thought to be nonexistent or universally ignored.
Today we have just the opposite -- we have worries stacked on worries. From European deflation and double dip recession fears, to rising debt levels around the globe, to fears about state budget and pension plan deficits -- and I could name many more on any given day. The point is, a decade later the most pervasive bubble in my view is the negativity bubble. With regard to the positives, technology today is in many ways delivering on the promises of the halcyon days with video streaming over mobile devices, telepresence computing, storage tech advancing by leaps and bounds, and various forms of entertainment beginning to fully utilize the computing power on a truly global scale.
As I outlined in a couple of my 2009 Themes titled Regression to the Mean, and reiterated again this year in Tech Themes for 2010, I stated:
Regression to the mean. This may be the most profound theme, and if it comes to fruition to any degree, then 2009-2010 should produce materially higher returns than expected. We're currently at record levels for the worst rolling 10-year period in the stock market and worst calendar year by a long shot. To put it plainly, we need earth-shattering returns to completely close the gap and get back to the S&P's 9% plus long-term average.
So far so good for 2009 as the year made up for some serious losses that started in the last quarter of 2007. However, even after one good year of returns, we're still tracking near record-low decade-long returns. These sort of anomalies take a number of years to correct. While 2010 so far has started shaky with bursts and headfakes in either direction, I suspect 2010, as well as the next decade's returns, will be higher than normal, though contain above-average volatility.
So what now? Have we had the correction, and what strategy(s) might work best in the coming weeks and months?
For technology shares specifically, owning a mix of companies while emphasizing companies on both ends of the "risk spectrum" is a way to invest for growth but also shield oneself from the frequent whipsaws that have characterized the year so far and I feel will continue for much of the remainder of 2010.
What I'm referring to is what I call a "barbell strategy" to the tech market. For this structure I'm proposing a blend of owning the very highest quality tech names with low volatility combined with speculative holdings that have higher absolute total return upside but much higher levels of risk/volatility.
In my style of portfolio optimization, there are caveats for the high risk stocks:
1. Low balance sheet risk -- I'm looking high net cash with preferably 25-40% of the total market cap in net cash.
2. Niche leader.
3. Growth -- I still want to see some kind of new growth catalyst. No value traps for me.
4. Weight on the barbell -- I won't even put 50% of the barbell into the more speculative names. For others, this tolerance may need to be well lower, such as 35% or even 15% into the higher-risk tech names.
So onto the names. On the low-risk side I'm going with stocks that actually meet all the criteria above plus a few kickers. Names such as Microsoft, Broadcom (BRCM), Google (GOOG), Texas Instruments (TXN), EMC Corp (EMC), Cisco, and Apple all have very dominant franchises while selling as cheaply as 1997. The quad-Q's can easily be substituted and all of these are growth stocks selling at value stock multiples with multiple growth catalysts converging.
The kicker I was referring to is that every one of the above has reported strong recent quarters (and guidance) -- in many cases handily beating both the guides for revenues and net income, while also producing copious amount of free cash flow. Some have also initiated or increased their dividend yields.
For the high-octane part of the barbell, again I'm always evaluating stocks that meet all of my above criteria. One group of stocks that fits nicely are the potential M&A targets. These would be underperforming stocks with superb balance sheets like Electronic Arts (ERTS), Dell (DELL), MKS Instruments (MKSI) and Adtran (ADTN). Another area is the left-for-dead bandwidth names of the Tech Bubble's glory days -- names like JDS Uniphase (JDSU), Ciena (CIEN), ADC Telecommunications (ADCT), Arris (ARRS) and Tellabs (TLAB) all are showing solid growth again and some of these stocks are still well below their 2002 lows. (That fact alone is stunning given all these names are producing multiples of sales above 2002 levels.)
Lastly, the other way to implement the high-octane side of the barbell is to go after high-quality, industry-leading niche players. These names might have higher market caps but also carry higher betas, and many are still hugely off 2007/2008 highs -- Riverbed Technology (RVBD), ValueClick (VCLK), Micron Technology (MU), Cymer (CYMI) and Lam Research (LRCX).
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