Tech Stocks: Look Before You Jump

Last week was remarkable for technology investors. Share prices in this sector increased by 9.4%. After the market closed on Tuesday, Intel’s (INTC) second-quarter earnings announcement breathed life into the stock market and sent many tech names stampeding higher.

The good
Intel reported its strongest first- to second-quarter growth since 1988 and offered upbeat comments for the second half of 2009. Based on improving conditions in the PC market, the technology benchmark expects third-quarter sales to reach $8.5 billion, well above the $7.8 billion bill forecast by analysts. Commenting on the chip giant’s results, one analyst quipped: “Intel had a terrific quarter by almost every metric.”

This bullish enthusiasm continued through the week after International Business Machines (IBM) also beat analysts’ earnings forecasts. Relentless cost cutting through automation and shifting work to lower-cost locations allowed IBM to increase profits 12% to $3.1 billion, even as sales declined 13% to $23.3 billion. IBM’s earnings tally of $2.32 per share beat analysts’ forecast of $2.02 per share. The tech titan raised its 2009 EPS forecast to at least $9.70 a share, 50 cents a share higher than its January forecast.

The bad
Although Intel and IBM reported relatively strong results, the strength in operations did not resonate through other technology names. Nokia’s (NOK) forward-looking statement worried investors. Trailing rivals like Apple (AAPL) and Research In Motion (RIMM) in the smartphone race, Nokia cut its operating margin forecast on ‘mid-teens’ phones to around 10%.

Citing weak demand for computer hardware from business customers, higher component costs and a competitive pricing environment, Dell (DELL) lowered its gross margin forecast for its July quarter.

Invest in technology?
So, given that tech companies have mixed performance, is the tech sector worth investing in? Given the prospect of a stabilizing economy, I think the answer is yes. However, selectivity is key.

Look before you jump!
Fidelity Select Technology (FSPTX), Technology Select Sector SPDR (XLK) and Vanguard Information Technology (VGT) represent a sampling of broad technology-related sector funds and ETFs available to invest. Here’s how these investments have fared since the market bottomed on March 9.

FSPTX has led the pack with a whopping 70% return. This tops the 53% gain for VGT by 17%. XLK has lagged behind the pack with a 45% advance.

Why such differences?
As always, the devil is in the details. While FSPTX, XLK, and VGT all have technology in their names, they differ in holding market capitalization, industry exposure, and expense ratio. XLK includes telecommunications service companies, while the others typically do not. FSPTX often includes small- and mid-cap technology companies, while XLK and VGT are heavily skewed toward large-cap names.

Exposure to telecom service companies such as AT&T and Verizon is holding back XLK’s performance, while increased exposure to mid-cap names has helped FSPTX outperform the competition since March 9. Instead of choosing investments with the lowest expense ratio or highest trading volume, it pays to understand what your mutual fund or ETF holds.

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