SAN FRANCISCO — Tech stocks, helped by a return to favor of growth stocks in general, posted one of the best performances of any sector in the first half of 2007.
If you want to capitalize on a second-half run, though, you're going to need to look at five names that some of the industry's most experienced and successful growth mutual-fund managers say look particularly well-positioned.
And just as importantly, these tech mavens — all of which are big, established blue-chip businesses — have the girth to help cushion any fall if the 2007 rally in the stock market reverses course.
Among the favorites are '90s sirens Cisco Systems Inc., Texas Instruments Inc. and Hewlett-Packard Co. Other prominent oldies but goodies moving up managers' portfolios are Adobe Systems Inc. and Oracle Corp.
For the most part, they've lagged runs by smaller, more nimble rivals. Midcaps such as Ciena Corp. and Intersil Corp. have been some of this year's biggest overachievers.
But with tech's rally still in its early stage, managers are playing it cautious, sticking to bigger operators with less hypergrowth potential and more sustainable prospects.
"While we're seeing more mutual-fund managers moving into the growth side of the market, large-cap names seem to be increasingly attractive," said Russ Kinnel, director of mutual fund research at Morningstar Inc.
Even though growth stocks' seven-year drought seems to have come to an end, clear market leadership is still open to debate, says John Jostrand, co-manager at William Blair Growth Fund. "It's too early to tell who will wind up as the next Cisco of the world," he said.
In the meantime, Jostrand's sticking with the original leader in computer networking. And he argues that's not as staid of a move as some might think. Jostrand says Cisco has expanded into new markets, restructured and recast itself to make a run in coming quarters.
"Six or seven years ago, Cisco realized the initial growth phase of the Internet had been built out," he said. "It aggressively expanded into new markets and recast itself as a force in new technologies that will shape markets for years to come."
Jostrand expects the Silicon Valley tech giant to generate compounded annual average earnings growth of 19 percent through 2010. That's based on revenue growth of around 15 percent per year. "Their newer technologies are clearly proven now and their customers love it," Jostrand said.
Those include wireless broadband products such as local area networks for businesses. Cisco has also moved into video teleconferencing. In the first half of 2007, Jostrand estimates around 40 large companies have bought such high-tech systems.
Another big driver of Cisco's better-than-expected growth for the fiscal year that ends this month has been the acquisition of Scientific-Atlanta. Its lineup of set-top boxes and other cable gear has produced greater revenues than originally forecast. Cisco's recent deal to buy WebEx, a video teleconferencing provider, is expected to be a key growth driver in the next 12 months.
"With new equipment and services like these, we think that in the next three-and-a-half years Cisco can more than double its earnings," Jostrand said.
Christopher McHugh, co-manager at Turner Midcap Growth, is also favoring Cisco. He expects its earnings growth to wind up around 15 percent this year.
At the same time, McHugh notes the company's stock has returned less than 4 percent this year. "Investors seem to be taking a wait-and-see attitude to Cisco," he said. "But we see significant upside in this company. We believe we're in the early stages of a strong secular uptrend in enterprise networking."
Managers at Rainier Investment Management also own sizeable stakes in Cisco. But they say heading into the third quarter, Texas Instruments looks even better.
The Seattle-based shop runs about $14 billion in assets, mostly for institutional investors. But it also has four mutual funds for retail investors.
Chip makers are coming off a slow period marked by inventory cutbacks. "But that has run its course," Mark Broughton, a Rainier portfolio manager, said. "We're beginning to see inventories build again. That should help Texas Instruments in the last half of 2007 and beyond."
By Rainier's estimates, Texas Instruments is trading at 17 times 2008 expected earnings. That's about a 14 percent discount based on historical averages, say its analysts.
Wall Street's expecting around 11 percent earnings growth in 2007 for Texas Instruments. Rainier is forecasting slightly higher at around 15 percent. "But we still think that's rather conservative," Broughton said.
With the popularity of Apple Inc.'s iPhone and coming clones, he adds that Texas Instruments' chips should get a boost in the second half of 2007.
Another play on rising sales of peripherals, from smart phones to digital printers and cameras, is Hewlett-Packard Co.
"They're strong players in digital devices, which have higher profit margins than PCs and other more traditional computer markets," said David Scott, lead manager at Chase Growth Fund.
Hewlett-Packard is now one of his portfolio's largest holdings. It's a turnaround story he says wasn't very appealing until recently. "They've stabilized management, reduced costs and streamlined operations," Scott said. "They're more of a classic growth play now with a good sustainable upside going forward."
He's looking for calendar 2007 earnings growth for Hewlett-Packard of better than 20 percent. "Their strategy is to continue to bring new products to market that successfully shifts their focus back to retail distribution," Scott said. "They've forced Dell, which had been concentrating on direct sales models, to enter the retail channel. It shows that they've been able to move the battle for new customers into HP's sweet spot."
Another of his favorites as the fourth quarter approaches is Oracle. It's known as a database software developer. Through acquisitions, Scott says Oracle has become a major player in business applications. "And they've been able to integrate numerous acquisitions, both large and small, successfully into their existing business," he said.
Scott says he's expecting Oracle's EPS to wind up around 16 percent in calendar 2007 and 2008. The firm, which ends its fiscal year on May 31, should also produce mid-teens revenue growth, he adds.
"It's a stable, mid-teens growth company with upside potential to exceed those numbers if they're able to continue to improve operations," Scott said. "In the short run, I wouldn't be surprised to see Oracle reach 20 percent earnings growth rates."
The stock is trading at a multiple of around 17 times this year's expected calendar earnings, he added. "Over the last five years, it has traded as high as 32 times and as low as 15. So we're at the low end of its historical range."
Software maker Adobe Systems is another large-cap name William Blair's money managers say they're expecting to perform relatively well in the final two quarters.
The San Jose, Calif.-based firm sells tools to other software developers for Web design, video production and online publishing. "They're in the middle of a very important product upgrade," Jostrand said.
The company's working on making sophisticated Web site production tools such as animation and video more user-friendly. "Advertising on the Web is growing much more dramatically than other forms of media such as newsprint and television," Jostrand said. "Great video, ease of use and good design are what's drawing more viewers to Web sites. So it's very important for their customers to have as good of production tools as possible."
The idea is to create more of an interactive feel to Web sites. If Adobe can do that, it hopes online traffic will keep eyeballs longer and retain customer loyalty better.
"They're already the dominant player in document publishing and Web site design," Jostrand said. "But they're forging new niches for themselves."
That includes bringing more graphics to cell-phone production. "We're very confident that's going to work out," Jostrand said. "Mobile device carriers are facing increasing competition. Providing their customers with the ability to view sports clips, play video games or view music videos on their handsets is going to be a key way they separate themselves from the competition."
He's expecting revenue growth by Adobe north of 25 percent in the second half of 2007. Jostrand forecasts earnings growth to be even slightly greater.
"They're in the front-end of a healthy, long-term new product cycle run," Jostrand said. "So growth should be faster than normal in the next several quarters."
Murray Coleman is a reporter for MarketWatch in San Francisco