Magazine article Newsweek

Safe to Return to the Water? Risky Business: Last Year's High Fliers Deserve a New Look. Don't Forget the Potato Chips for Balance

Magazine article Newsweek

Safe to Return to the Water? Risky Business: Last Year's High Fliers Deserve a New Look. Don't Forget the Potato Chips for Balance

Article excerpt

Do you still have the stomach for technology stocks? If so, there are two qualities you should always look for: innovation and valuation. It was a relentless focus on innovation in the networking sector that made Cisco Systems a stock-market icon in the late 1990s, and if the company's share price rebounds any time soon, it will be because it continues to innovate. Similarly, innovation propelled the Palm to the top of the handheld-device industry. Innovation in telecommunications enabled Qwest to take over the Baby Bell U.S. West.

Innovation cuts both ways, of course. Atari was an early innovator with its video-game technology. Today its machines are yard-sale material, victims of superior innovations from gamemakers like Nintendo and Sony. VisiCalc touched off a business revolution with its spreadsheet software in the late 1970s, but that market now belongs to the Microsoft juggernaut with Excel. It's not enough to innovate once. You have to keep it up. Apple Computer turned the PC industry around when it rolled out the Macintosh in 1984, and then gave in to complacency.

For the investor, too, taking innovation into account isn't enough. Paying attention to valuation, or the price being paid for a stock, should always be an element of an investment strategy. While it may be true that an investor can "pay up" somewhat for a high-quality business and still come out all right in the end, there are limits to this logic.

"Buy and hold," for example, does not mean buy at any price, even for a tech stock on the verge of setting the world on fire. If stock prices reflect future expectations (which they do), there must be room in the stock price for when these expectations become a reality. And the more room, the better for the buy-and-hold investor in technology stocks.

To use Cisco Systems as an example again, the company famously reached a peak market valuation of $592 billion in the spring of 2000, when its stock price briefly reached $80 a share. …

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