(04/12/12) 2 Tip-Top Tech Stocks

Many investors look to commodities and industrials to gauge the health of the economy, and thus the markets, but perhaps they should be watching Big Tech instead, posits Elliott Gue of Personal Finance.

The 2000 technology bust and subsequent collapse of the high-flying Nasdaq left many investors with the perception that technology is a high-risk, volatile sector that’s only appropriate for the most aggressive growth investors.

That sentiment is downright anachronistic. The S&P 500 Information Technology Index has a beta of 0.96 over the past five years. (Indexes with betas lower than 1.0 are less volatile than the broader market.) More important, technology stocks have outperformed the broader market by a sizable margin despite their below-average risk.

Technology is the most cash-rich and least indebted sector in the S&P 500. Some of the bigger tech stocks generate so much idle cash, they’re initiating dividends to return value to shareholders. Tech companies now hold 30% of all cash among non-financial balance sheets in the S&P 500 ($360 billion out of $1.1 trillion).

What’s more, the technology sector enjoys significant growth opportunities in the years ahead. Mobile devices such as smartphones and tablet computers have transitioned from niche products into the mainstream. Between 2010 and 2012, total tablet sales are expected to more than quintuple.

Technology ranks alongside energy as the top-weighted sector in the Growth Portfolio. Here’s a look at two more attractive names in the group.

Intel Inside
The world’s largest semiconductor company, Intel (INTC) has been at the heart of the PC revolution of the past two decades.

The company’s most important products include microprocessors, the integrated circuits that execute programs and perform all the functions of a computer’s central processing unit (CPU). Intel also produces chipsets that transfer data between the CPU and various devices on a computer system.

Intel’s PC business remains its largest operating unit, accounting for two-thirds of sales last year, down only slightly from just over 71% of sales in 2009. Intel maintains a commanding market share in PC microprocessors, estimated at over 80% of global sales.

The company is unlikely to cede that lead anytime soon, thanks to its unparalleled research and development (R&D) budget that totaled $8.4 billion in 2011. In comparison, competitor Advanced Micro Devices (AMD) last year invested only $1.5 billion in research and development.

One of the fruits of the company’s massive R&D budget is its so-called “tick-tock” strategy, by which the company introduces a new generation of more powerful chips every two years. In 2003, for example, the company introduced its 90-nanometer technology and its 32-nanometer in 2005. The company in 2011 introduced 22-nanometer technology. A nanometer is a measure of size; smaller chips are more complex and powerful.

Intel is positioned to benefit from several catalysts for growth this year. The introduction of the Windows 8 operating system toward the end of 2012 should drive an upgrade cycle in PCs, powering demand for Intel’s more advanced chips. Moreover, Apple’s (AAPL) popular MacBook Air, measuring as little as 0.68 inches thick and weighing less than 2.4 pounds, created a new class of light, thin laptop PCs dubbed “Ultrabooks.”

The Air already uses an Intel processor, and the company has been working with other major manufacturers, including Hewlett-Packard (HPQ), to develop similar products slated to launch in 2012. Heavy marketing of Ultrabooks this year should generate additional PC unit growth for Intel.

Up Next: Intel derives about one-fifth of its revenue from...

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Intel derives about one-fifth of its revenue from processors and chipset platforms used in servers. This unit is by far the company’s most profitable, generating operating margins well north of 50%, compared to around 30% for the company as a whole. Intel’s Xeon line of server processors holds a near-monopoly in the server market, with a global market share estimated at slightly below 95%.

Thanks to growth in “the cloud,” the server business provides stronger growth prospects for Intel than PCs. The cloud comprises Internet-based computing that allows organizations to increase IT capacity or add capabilities on the fly without investing in new infrastructure, training new personnel, or licensing new software. By saving files on the cloud rather than storing them locally, users can access all their files from any device.

Apple offers a similar service called iCloud. Software applications, calendar updates, television shows, and contact numbers saved on one Apple device are automatically pushed to all other devices connected to iCloud, such as a Mac laptop, iPad, Apple TV, or even a Windows-based PC.

Another example is software as a service (SAAS), whereby a company provides software to users via the Internet rather than individual copies for storage on each PC and laptop. This allows the software company to update its product centrally, ensuring that every user has the most up-to-date version.

The cloud is fast becoming one of the hottest trends in technology, but building out a cloud-based system requires massive investments in new servers and data centers. Strong server demand is powering growth for Intel’s products; the new Romley Xeon E5 processor released in early March firmly cemented the company’s technological leadership.

Intel has lagged competitor ARM Holdings (ARMH) in the mobile market, including chips for smartphones and tablet PCs. However, Intel’s newer Atom line of chips appears far more competitive with ARM. Intel also has announced a series of partnerships with companies including industry giants Motorola Mobility (MMI) and Lenovo (LNVGY) to supply chips for certain Android smartphone models.

Strong growth in sales of mobile devices will be a significant tailwind for Intel, despite its lower market share in this niche. Considerable room for growth also exists in emerging markets, as the multimedia capabilities of smartphones enable millions of people in developing countries to access the Internet. Intel is poised to gain a sizable presence in these markets, because of its expertise in building chips based on low-power designs.

Intel has a solid track record of returning value to shareholders and offers a roughly 3% dividend with the potential to boost that payout by around 10% this year. Intel is the newest addition to the Growth Portfolio, as a buy under $29.50.

The Nimble Acrobat
Adobe Systems (ADBE) develops and sells products that allow users to share information across all print and electronic media.

The crown jewel in Adobe’s product line is Creative Suite (CS), a portfolio of software tools to create online and printed documents including Web sites, newspapers, magazines, brochures, and books. CS has become the industry standard, and many creative professionals learned their craft using CS software. Designers switching to a competing product would have to learn an entirely new software platform, giving CS a high degree of customer “stickiness.”

CS product cycles historically have driven Adobe’s stock price. The company now is selling CS5, with a new version of the software due in May. According to a recent company survey, 40% of existing CS5 users are interested in upgrading to CS6, suggesting rapid market acceptance.

CS6 will introduce new features likely to be embraced by many design professionals as critical, including support for HTML5, a language for structuring content on the Internet. The new software will include tools that facilitate development of mobile applications, as well as tools designed for tablet computers.

CS6’s “Creative Cloud” offering also will allow users to subscribe to CS6 as a software-and-service bundle, reducing the upfront cost of buying the product. Creative Cloud will offer users access to both Mac and Windows versions of all software, providing the option of a subscription model for the company’s highly popular tools.

Adobe Systems rates a buy under $36.

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