Tech Industry

Investors still shun some Net giants

Despite predictions of a flight to quality among Net stocks, the shares in some profitable companies are languishing.

Where's the so-called flight to quality?

When the markets tanked a couple of weeks ago, countless analysts said investors would become more picky about the Net stocks they would keep in their portfolios, favoring real profits and market dominance over "potential."

It's true that many of the smaller, profitless Net stocks that were hit hardest have yet to bounce back. But the shares of some bellwether companies are languishing, too.

Industry titans Yahoo and eBay, for example, have posted stronger-than-expected profits since the market correction, but their stocks have yet to recover their losses or to even outperform the Nasdaq composite index.

Yahoo, which is viewed as an industry leader among portals, last month posted revenue and profit growth, excluding charges. The earnings also slightly beat Wall Street forecasts.

Nevertheless, the company's shares are down 36 percent since they topped 200 on March 27. The Nasdaq has dropped 21 percent during the same period.

Online auctioneer eBay handily beat analysts' first-quarter earnings estimates last week and announced a 2-for-1 stock split. Its reward: The shares are down 38 percent since March 24.

The broad nature of the sell-off in Net shares shows that investors have not yet distinguished between the leading and lagging companies, said Michael Parekh, managing director and head of Goldman Sachs' Internet research.

"We found that in the initial stages of (market) weakness, the sectors compress because investors don't sort the baby from the bath water," Parekh said. "Once the broader tech market stabilizes, then we'll see a re-prioritizing of companies and investors seeking ones that are profitable."

During the past six years, the Goldman Sachs Technology Index has recorded 15 periods of weakness that have lasted between 15 days and five months. Of those 15 periods, the decline has ranged between 7 percent and 23 percent. The current period ranks as the most severe--a staggering 42 percent year-to-date.

Driving this volatility have been concerns about valuations--more so than a company's fundamentals--and fears about rising interest rates.

"A lot of investors want to wait for the markets to clearly turn around. No one wants to catch a falling knife," said Merrill Lynch analyst Henry Blodget. He added that some investors have already begun to buy some of the more "solid" companies.

Institutional investors, meanwhile, say they are weeding through their portfolios and cutting under-performing or smaller holdings, but their buying activity is far from a binge.

Huachen Chen, co-manager of the Dresdner RCM Global Technology Fund, said he cut about 15 percent from his fund in mid-March. Most of the companies cut, including security software maker Aladdin Knowledge Systems, had ultra-high valuations, Chen said. In early April, as market conditions further deteriorated, he whacked a whopping 30 companies from the 85 held in the portfolio.

"We moved into more conservative stocks like Intel and Dell and added to our positions in Commerce One, Ariba and i2," Chen said, noting that the degree to which he is buying is not substantially above a usual pattern.

Anthony Rizza, portfolio manager for the Nuveen Innovation Fund, said he began moving toward higher-quality names three weeks ago, but his buying has been "normal."

He added that he does not expect to see a huge swell toward blue chip stocks until fears of interest rate hikes ease and more companies begin to hit their profitability schedule.