The Tech Sector Comes Full Circle, to Totally Undervalued

There’s a not-so-fine line between a stock merely being cheap, and a stock being undervalued. The tech sector currently falls well on the ‘undervalued’ side of the scale.

And that’s a far stretch from the way things were about this time ten years ago. In late 1999, it wasn’t unusual for tech price/earnings ratios – or as we say, the price of profit – to be in the triple-digits versus the markets norm of around 20 (or less). For that matter, earnings were largely optional for these companies. Yet, the technology sector rallied despite every reason for it not to….. until the beginning of the end in March of 2000.

In the same way investors didn’t believe tech was overvalued then, investors are having a hard time accepting that technology stocks are undervalued now. Yet, the numbers are pretty undeniable.

By any measure: From a ‘price of profit’ point of view, or the price/earnings ratio, technology stocks technically aren’t the cheapest right now. They are, however, the cheapest relative to their forecasted growth for the next five years… at least according to Standard & Poor’s. [Investors should generally be willing to pay a premium for greater growth….within reason.]

Doubts about forecasts? Fair enough, but know that it was also the technology sector – with the skewed exception of the financial stocks – that posted the biggest increase in year over year revenues last quarter (+8.8%). It was also the sector that posted the second-biggest number of positive earnings surprises for Q4 of last year (89%).

Translation… not only are analysts underestimating these names, these companies truly are doing better.

Naming names: Were it just one or two companies in the group with stronger numbers, the pro-argument may not hold water. It’s the vast majority of these stocks though, across the board, and regardless of size. Hewlett-Packard (NYSE:HPQ), Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), and IBM (NYSE:IBM) all saw bigger top lines and bottom lines last quarter than they did in the same quarter a year earlier.

Notice those companies come from four distinctly different technology arenas, and they each managed to show improvement. The numbers make it hard to argue that universal consumer and business spending isn’t on the mend.

Yet, tech stocks remain at multi-year low valuations; some analysts even feel certain groups are undervalued by as much as 17% for 2010. A Bloomberg poll of tech analysts, for instance, sees tremendous value in computer companies, suggesting Dell (NASDAQ:DELL) shares could gain as much as 28% this year.

Bottom line: The market has a way of going to extremes. It’s just that this time, the extreme is the diametrical opposite of the extreme witnessed throughout the late-90’s tech bubble. Technology stocks are as inexpensive as they’ve been in over a decade. Of the four companies mentioned above (GOOG, IBM, HPQ, and MSFT), their average projected price/earnings ratio is only 12.7. Such a number would have been unheard of a little over ten years ago. Time to go bargain shopping.

If an individual tech name still poses too much risk, an exchange-traded fund like the Technology SPDR ETF (NYSE:XLK) or the iShares Technology ETF (AMEX:IYF) would work just as well.