What's sexy in tech? Big & boring or maybe nothing

By Paul Thomasch - Analysis

NEW YORK (Reuters) - When IBM surprised investors with an unexpectedly strong preliminary earnings report Wednesday night, some hoped it might throw a lifeline to the technology sector amid sinking financial markets.

But such optimism quickly fizzled on Thursday as fears of a global recession dragged down almost all tech stocks, with even IBM itself ending down 1.7 percent.

While that is not bad in this climate, when the Dow Jones Industrial Average fell 7 percent Thursday, even investors bold enough to bet on a bottom for technology are playing it safe. They say only a handful of the biggest and most steady companies could hold up during this upheaval.

Some like Intel Corp and Microsoft Corp along with IBM, saying they are better bets now than last year's darlings like Apple Inc or Google Inc, which both still trade at relatively expensive valuations.

"It's sometimes tough to jump in front of the oncoming train, but at some point people have to," said Zach Rosenstock, an analyst at Wayne Hummer Wealth Management. "I would definitely stay with the bigger names: Intel, Microsoft, IBM, Hewlett-Packard. Boring names, but that's where I would be."

International Business Machines Corp, the world's largest computer services company, posted on Wednesday a higher-than-expected 20 percent rise in third-quarter profit and affirmed its outlook for the full year.

The news initially pushed up IBM and other tech stocks, but the rally proved unsustainable on Thursday as the broader U.S. market fell for a seventh straight session. The S&P Information Technology index ended down 3.43 percent.

Even IBM, with its appealing price-earnings ratio, solid dividend and recurring profit stream, failed to completely win over investors. Its profit beat expectations but revenue growth was relatively weak, causing concern both for IBM and what it reflects about the rest of the technology sector.

"This is a company that has a much larger amount of recurring revenues than other companies. They also are in every part of the world," said Rosenstock, whose firm owns IBM, Microsoft, HP and Intel shares. "If they can't grow anything, I find it hard to believe other companies will be able to."

CHERRY PICKING

Analysts cautioned that many tech companies do not share IBM's advantages -- scale, reach into emerging markets, and steady income from services and software contracts -- and yet they will face the same economic headwinds that crimped Big Blue's revenue growth.

"IBM's solid third quarter results -- and more importantly its outlook for the fourth quarter -- are positive data points for the market, and will likely be viewed with relief by investors," Sanford Bernstein analyst Toni Sacconaghi wrote in a research note. "However, we caution investors from extrapolating broadly to other names for several reasons."

One reason is that IBM generates almost 60 percent of its profit from recurring sources like services and software contracts -- spending that tends to hold up better during tough economic times.

Another reason is that IBM trades at a discount to the S&P 500 index, even though its earnings growth should be better than the broad market.

IBM shares trade at nine times forecast 2009 earnings. Compare that with Apple's 15 times and Google's 14 times.