Tuesday, 27 April 2010

Tech Stocks Revisited Ten Years After the Bubble

Remember tech stocks and the gigantic bubble of the year 2000 followed by the equally severe crash to the bottom in October 2002? How could we forget with the troubles that ensued from the subsequent demise of many companies, which persist to today, most notably with Canada's former tech leader Nortel. What has happened since 2000 and what lessons can be learned?

Tech Stocks have not yet recovered to the peak! - Ten years on, the value of tech shares as a whole are not even close to attaining the peak attained at the end of March 2000. An investor who had bought at the peak an ETF like the Technology Select Sector SPDR (symbol on Amex: XLK), which holds a broad array of tech companies, would be down about 60% as of April 20, 2010. This is much worse even than the overall market, as measured by the S&P 500 Index, which is still 20% below the March 2000 high water mark (see chart below from Google Finance)

Even when measured from much earlier in the bubble on January 1, 1999, before the last euphoric rise through 1999 and early 2000, tech stocks are still down. A small dividend yield, not reflected in the above price graphs (the effects were discussed recently in TSX Composite and S&P 500 Total Market Return) reduced the loss somewhat but since its inception December 18, 1998, XLK has produced total returns averaging minus 1.6% per year. Add in the loss of purchasing power from inflation and, for a Canadian investor, the rise of the Canadian dollar over the US dollar (it has gone up from $0.65 then to more or less par today) and the results can only be termed awful.

Lesson: Once a bubble bursts, it stays burst. A miraculous bounce back doesn't happen and recovery takes a long, long time.

Tech stocks now track the overall market - In the time since the tech crash bottom in 2002, XLK, blue line in the Yahoo Finance chart below, has followed the general pattern of the S&P 500 Index, the orange line, but with peaks and dips. Ironically, the most recent section of the line over the past year and a half has remained consistently above the S&P500 because tech stocks did not fall as much during the 2008 crash when financial stocks declined the most. Since the March 2009 bottom, XLK has paralleled the S&P 500 very closely. This should not be too surprising since the tech sector comprises the largest single sector of the S&P 500, constituting about a fifth of the asset weighting.

Lessons: Tech stocks have slowly become normalized after the 2000-2002 bubble and crash and now are a core part of the stock market, reflecting the fact that information technology and the Internet play a key role in the economy. The length of the tech stock recovery, noted above, is actually a good thing. The stocks are being treated more in line with the overall market.

Most tech stocks have been losers but some are big winners - While the average and the overall mass of tech stocks has been down, when we drill down into individual companies we find a big majority of losers (again, we note, in reference to the bubble years) while a few have powered ahead and have even far exceeded the former peak of 2000.

The difference between the winners and the losers is not due to the success or failure of the company. Nortel's surviving competitor, Cisco, though consistently profitable, has not done wonders for its shareholders. Company success has not equated to stock investor success.

Stock Losers:
Among the highly profitable tech companies, whose names are well known to most people, and which have survived and thrived through the bubble years and continue to do so nowadays, but whose stock has languished as shown on the chart below, are: Microsoft (symbol: MSFT), Cisco (CSCO), AT & T (T), Intel (INTC), Hewlett Packard (HPQ), Oracle (ORCL) and Yahoo (YHOO).

Stock Winners:
On the other hand there are companies which have provided returns ranging from the weakly positive like IBM (IBM), with a 23% gain in ten years, to the middling, such as Symantec (SYMC), right up to superstars such as Apple Computer (AAPL) with a 678% stock price appreciation, Google (GOOG), up 412%, and Canada's very own Research in Motion (RIMM), up 228%. However, as the chart below illustrates, there have been lengthy periods when the stock was in losing territory and other times of significant drops. How many investors could and did retain their faith in the future and actually achieve those gains, one wonders?

The big question - why have some successful companies' stock performed poorly while others have done well? The answer is as individual as the company as one or more possible reasons may come into play:
  • Fads - The same mass psychology that caused the tech bubble and crash, has not disappeared and some companies may benefit, or suffer, from this factor
  • Future growth prospects - Investors may bid prices up or down, justifiably or not (see fads above!) according to whether the company is in the right or wrong segment e.g. are Apple products, iPhones, iMacs, iPods, etc not the rage currently and in the sweet spot of public demand? Does Microsoft seem a bit passé?
  • Employees get the profits, not the shareholder - Some tech companies seem to make a habit of issuing huge amounts of stock options to employees, diluting the share base, and then buying back shares with cash profits, which in effect is an indirect payment to employees.
Lessons - With the bubble and the crash long past, the only way to proceed vis-a-vis individual companies is to dive into the analysis of each company - its financial statements, its market position and products, its competition etc - the traditional disciplines of stock assessment. Failing that, owning tech stocks through a broad diversified fund - perhaps a tech ETF such as XLK, or a general market fund such as an S&P 500 or a Total Market fund - is the cautious way to go.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

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