The Reignited Tech Sector

By the end of 2000, Americans had ended their love affairs with a lot of fads. The "Whassup?" beer ads, the singing Big Mouth Billy Bass, colored ketchup -- all were loved, then quickly forgotten. But even after the tech bubble burst disappointed countless investors, one never got the sense that Americans ever fell completely out of love with technology stocks. So perhaps it's not surprising that after nearly a decade of staying away from them, investors are willing to give their old darlings another shot. And this time, according to some analysts, there's reason the romance might last.

In the words of David Darst, chief investment strategist at Morgan Stanley Smith Barney, tech stocks have "come alive." After a tremendous run over the past six months, tech stocks make up nearly 21 percent of Standard & Poor's 500-stock index. That's well above the 15 percent they accounted for in 2007. The charge has been led mostly by consumer-centric tech names like Apple (AAPL). Such firms have proved particularly adept at expanding into fast-growing emerging markets, where eager customers from Brasil a to Beijing have been lining up around the block for iPads and other hot gadgets.

That's hardly surprising, experts say, because ever since the financial crisis in 2008, corporations have tightened their purse strings, spending less money on what they call "capital expenditures," such as mainframe computers, software upgrades and data storage. But the next tech bull run might be in the shares of firms that cater to corporations. Experts say corporations need to refresh their technology every few years to remain competitive in their industries. "It is like driving a car that was okay at five years, but after eight or 10 years, you need to replace it," Darst says.

Technology analysts predict that demand will pick up all along the supply chain for computers, data storage and IT infrastructure. A historic transition is under way both in developing countries -- which are investing in more computers -- and in developed countries, where data storage is moving from old desktop computers and office servers to the Internet, or "the cloud," as it's known in the industry. Many of the companies that could benefit from these trends are the old blue chip tech stocks that have been mostly dormant for years, such as Intel (INTC), EMC (EMC) and Microsoft (MSFT), but which have started to perk up this year. "As CEOs become more confident, they are more likely to spend money on capital expenditures," says William Delwiche, an investment strategist at Robert W. Baird.

New Tricks From Tech's Old Dogs

After years of tightening purse strings, corporate chieftains need to spend freely on technology again to remain competitive, says David Darst, chief investment strategist at Morgan Stanley Smith Barney. He says some old-guard computer stocks might be the biggest beneficiaries of this pent-up demand.

Software: Microsoft's P/E of about 11 and its 2.8 percent dividend make it a value stock, experts say. Morgan Stanley expects the company's new Windows 8 operating system to be a hit with business customers.

Consulting: Once the king of computer hardware companies, IBM (IBM) makes more money telling firms what to do with computer gear than actually selling it. Big Blue has the endorsement of Warren Buffett, who recently said that the stock had become the second-largest holding in the Berkshire Hathaway portfolio.

The best news about the tech-stock romance this time around, some money managers say, is that it isn't burning too bright, too fast. Joseph Tanious, global market strategist at J.P. Morgan funds, says that, unlike at the height of the dot-com boom, many tech stocks still have attractive valuations. Yes, there are a smattering of red-hot darlings that sport valuations that are 1999-esque; social networking firm LinkedIn (LNKD), for instance, has a price/earnings ratio of 890. But this time around, those lofty valuations are more the exception than the norm. The average P/E for S&P 500 technology stocks is about 16, only slightly higher than that of the broader market.

Indeed, some experts say that the stocks have been held back because of lingering bad memories of the now-long-ago tech bust. Tanious says many of today's companies in the sector are more mature than those of the go-go era, hold more cash on their balance sheets and -- something that was almost unheard of in 2000 -- actually pay dividends. "They've gotten better at making money," he says.

Yet the shareholders of many tech-sector funds might be wondering, "Where's the love?" The average return for actively managed tech-stock funds was about 8 percent last year, far behind the 15 percent return for the tech-stock-heavy Nasdaq. Experts attribute this disconnect to one stock: Apple, which has climbed to nearly 20 percent of the Nasdaq's market capitalization. Most stock fund managers aren't comfortable putting 20 percent of their portfolio into a single stock, and many are restricted from putting more than, say, 10 percent into one holding, making it tough for money managers to keep pace with an index that has become dominated by a single stock. (Since the beginning of this year, the tech-sector funds have kept pace with the index, despite having an average holding of 9.5 percent in shares of Apple.)

Some fund investors have clearly been at a loss over how to respond to this dilemma. Last year, shareholders withdrew more than $4 billion from actively managed tech funds. But in the first three months of this year, they piled $4 billion back into the sector, bringing the funds' total assets to around $28 billion. Flynn Murphy, a mutual fund analyst at Morningstar, says some tech managers have been scouting eagerly for undervalued and unloved stocks -- another big difference from the dot-com age, when few managers embraced the value mind-set. In those days, of course, metrics like "eyeballs" and website "stickiness" were cited in lieu of P/E ratios.

But then, even if tech stocks are on firmer ground this time around, investors might not want to double down quite yet. Murphy points out that many people already have plenty of exposure to tech stocks, especially if they own broad-based index funds or exchange-traded funds. Also, with the tech sector once again making up a large portion of the S&P 500, some experts say a separate technology-stock portfolio is not necessary for everyone. For many investors, an S&P 500 stock fund or a Russell 2000 stock fund "is already giving them a reasonable exposure to the tech sector," Murphy says.