If you were a high-technology investor in the past 12 months, the last thing you probably want to read about is high-tech stocks. Most of these issues plummeted to a point that would make even the most patient investor panic. But if you feel bad, think how Albert Toney feels. Toney, a general partner and portfolio manager for Hambrecht & Quist Equity Management in San Francisco, is a specialist in high-tech securities. He is also the author, with Thomas Tilling, of High Tech: How To Find & Profit From Today's New Super Stocks (Simon & Schuster, New York City; 1983).
Wondering how super these stocks look to Toney today, INC. staff writer Lisa R. Sheeran asked him for the current lowdown on the high-tech scene.
INC.: You are a portfolio manager for high-tech stocks, and you have been something of a cheerleader for them in the past. Were you surprised when they took a dive?
TONEY: I wasn't surprised that they took a dive, but I was surprised that the dive was so deep. The smaller speculative issues, which include a lot of high-tech stocks, were quite overpriced relative to the rest of the market. So either the rest of the market had to catch up or the speculative stocks had to move down. Unfortunately, the latter happened -- and continued to happen through the end of 1983. Then, contrary to what most people expected, interest rates moved up in January. That brought everything down. And since high-tech stocks tend to be more volatile than the stocks that make up the market averages, they tend to come down more than the market. This second stage was a surprise.
INC.: "Overpriced," you said. Some people think high-tech stocks are always overpriced.
TONEY: The typical high-technology stock we look at has a financial performance -- return on equity, margins, turnover, and so forth -- roughly twice as good as the companies making up the market averages. So you might expect it to sell for twice the price of the market. You can I make some reasonable judgments about when things have gone too far by comparing the price of these stocks with the rest of the market.
INC.: You also mentioned volatility. Are high-tech stocks volatile simply because most of the companies are young?
TONEY: Only partly. Contrary to popular perception, these companies as a group don't tend to have more volatile earnings. What affects the stocks is the volatility of people's expectations. The companies are treated as growth stocks, and are affected more than other equities by changes in expected future dividends, selling price, or interest rates.
INC.: What is your working definition of high tech?
TONEY: Our first criterion is growth potential. If the industry is not expanding, we won't include it in our universe, even if the technology is sophisticated. Nuclear power is high tech but the industry isn't growing, so we don't include it. Second, the companies either are involved in some form of electronics or are a direct beneficiary of changes in the electronics field. This includes telecommunications, the computer industry, medical fields that are affected by electronics, companies producing military electronics, and software, along with the distribution functions related to these industries.
INC.: These companies must have some distinctive characteristics. In analyzing them, what do you look for?
TONEY: The ideal high-tech company is one whose fortunes are driven by technology. The personal computer industry, for example, is market-driven rather than technology-driven. In a mass market like that, the technology has to have slowed down enough to allow volume production. This implies that distribution and sales capability are the key skills, whereas if you are selling some exotic widget to a guy in a lab, you may not need those skills.
If the company is technology-driven, your assets in many ways are intangible: They are in the heads of the people. In traditional investment analysis, book value is an important criterion for deciding whether the company is appropriately valued. But in high technology, the value of plant and equipment may be much less important than the value of the thoughts in the president's head. So as a group, high-technology companies tend to sell at a high price relative to their book value. Also, the relative competitive position of a high-tech company can change very quickly. That's why many of these companies are run with a fairly conservative financial structure. If your competitor across the street has an improved widget and he's killing you, you're going to have to double your R&D budget to catch up to him. And unless you have a strong financial situation, the situation could mean your death.
INC.: How important is a company's return on assets as a measuring stick?
TONEY: That is always important. It has the advantage of removing the effect of financial leverage, which you don't have using return on equity. And it s simpler for the inexperienced investor to use because it's the number at the bottom of a company's balance sheet. It's easy to find.
INC.: How about the company's size and age?
TONEY: Younger companies in general are riskier than older ones, but that's not a blanket rule. The importance of a company's size and age varies from industry to industry. And in some industries you may be better off with a younger company. For instance, the semiconductor industry is changing very rapidly now, and the companies that are apt to do best in the next recession are probably those in new product areas. So in this industry, I would be inclined to go with a younger company.
In the medical area, the markets tend to be small and fragmented and to saturate quickly. So it's sometimes better to seek a smaller company in this industry, too, because it is less apt to be nearing the end of its strength. In the personal computer industry, by contrast, a bigger company with more marketing capability is a better place to be than a company that has a better mousetrap.
INC.: What growth projections do you consider attractive at the moment?
TONEY: Those vary among industries. In general, 20% -- or 15% after inflation -- is a good floor; companies that are growing more slowly are usually not the kind we've been talking about. Computer-aided engineering, CAE, is one of the newer, faster-growing areas. If one of these companies isn't now growing at 30% to 50% a year, it's probably losing market share. So a 20% cutoff point for that industry wouldn't be very helpful.
INC.: Have high-tech stocks bottomed out -- and if so, is now the time to jump backin?
TONEY: High-tech stock prices are down to a fairly attractive level: The P/E ratios are about what they were in August 1982, when the stock market began its big surge upward. But market timing in this area is not as important as picking the right companies. One stock we like now, for example, is a military-electronics company called Anaren Microwave, traded over-the-counter. Anaren is selling at around 9 -- about 15 times what we expect it to earn in the next 12 months.
INC.: What's the average P/E for the high-tech stocks you are watching right now?
TONEY: We have a list of about 35 stocks we think are currently attractive, and the average P/E, looking out 12 months, is 12 times earnings.
INC.: What is your opinion on investing in initial public offerings? How do we know when an IPO is undervalued or overvalued?
TONEY: You don't know. That's one reason IPOs are dangerous. If the underwriter has done a good job in pricing the issue, he's priced it roughly within 10% of what he thinks it's going to sell for. We don't ordinarily invest in IPOs unless we think we're going to make 50% on our money in a year. That means we tend to buy relatively few, because if the underwriters do their jobs, there isn't that kind of money in them in the short run.
INC.: Let's take a look at some individual glamour areas. Genetic engineering, for example.
TONEY: The class of the group is still Genentech. However, I think this is an area for amateur investors to stay away from. Biotechnology companies are actually drug companies, and until prices get down to a level similar to drug companies, you will be paying too much. Most drug companies sell at a multiple between 9 and 15. Those biotechnology companies that have any earnings at all are still selling at very high multiples -- 25 to 35 times earnings. The cards are stacked against you. Besides, even if you are right on a company, it is going to take several years for the company to grow into that kind of price. In the meantime, you may have dead money at best. The stock may sell year after year at a trading range of 10 or 15 points and go nowhere.
INC.: What about robotics? That's an area we all hear a lot about.
TONEY: I feel the same way about robotics as about biotechnology: There's still too much stardust in people's eyes. In addition, there are a lot of venture-financed private companies that may turn out to be the most attractive investments in the field, and those companies really are not available in great number yet. One example is Intelledex. Automatix, a public company, just put in a new president, and I think that will improve its performance. But the company doesn't have any earnings this year.
INC.: How about cellular radio? Is this area too young, also?
TONEY: No, it's almost there, but we are not yet sure who the winners are. If I just couldn't stand it and I had to play it right now, I'd be inclined to invest in a Bell operating company because they are all guaranteed a seat at the stadium. You will be able to play those stocks without paying up for the mobile radio feature. The disadvantage is that mobile radio is a tiny fraction of these companies' results. But if it appears that this area is going to be successful, you may get a little stardust in the price of the telephone stock, and be able to sell it later on at a better price.
INC.: And the software companies?
TONEY: That's a very complex area because it's intimately tied to what's happening in computers. Cullinet [Software Inc.] is the leading contender in the mainframe software area, and is trying to develop networking software for personal computers. Lotus Development [Corp.] is the leading PC software developer. But even these leads are somewhat tenuous because progress in software is dramatic. It's possible that a new product could blow away the competition, just as Lotus did a couple of years ago with 1-2-3.
INC.: How about military technology? Should we wait until the Presidential elections before investing?
TONEY: If Mr. Reagan, who is perceived as supporting defense spending, is reelected, then defense stocks will probably rally in response. But if Mr. Mondale, who is perceived as being more economy-minded, is elected, there might be a sinking spell with these stocks. If you examine what really happens, of course, you will see that the difference between Democratic and Republican Administrations' actual defense-spending outlay is pretty small. The argument is over how fast spending is going up, not whether it is going up or down.
INC.: Finally, what is your best advice for investors who were in high-tech stocks and got out, or who never ventured into the area but are interested now?
TONEY: Generally, the best time to invest is right after a lot of bad news. After a year of declining prices, I think it's reasonable to say that the odds are considerably more in favor of making money from this point on. That doesn't mean it will be automatic. There is nothing that says the stock market has to stop going down after one year; it may continue going down for a year and a half or two years. I think the best thing to do is to average your way in -- invest gradually. It may take until early 1985 for the market to make significant upward progress, and in any event a major advance will probably not occur until after the Presidential election. So the smart thing to do would be to put a little money to work now, and then some more after the election.