Shares digital

Amid the current woe, it is the tech sector that has taken the biggest hit. Russ Mould takes stock and finds out why

Last week’s latest intervention by the US Federal Reserve in the US inter-bank one month lending markets, with the addition of an extra $200 billion of liquidity, was further proof the global credit crunch is still very firmly with us. Yet despite the gloom which envelops it, the banking sector has not been the worst performer in the UK so far in 2008. (see Table 1).

This dubious honour belongs to Technology Hardware & Equipment. This may seem surprising, as technology hardware firms have several characteristics which should make them ideal stocks for times as uncertain as these. Firstly, they generally keep net cash balance sheets, to help them ride out short-term trading operational volatility. The rising cost, and falling availability, of cheap credit should hardly be an issue for firms such as ARM Holdings (ARM) and its £51.3 million net cash pile.

Secondly, technology product cycles should see some firms generate secular growth, irrespective of the broader economic cycle. MTI Wireless Edge’s (MWE:AIM) leading share in the market for fixed wireless broadband antenna market offers huge growth potential from a booming sub-segment of the communications industry.

Thirdly, firms such as mobile phone expert ZTC Communications (ZTC:AIM) offer exposure to rapidly growing emerging markets such as China, where the West’s credit woes should have little impact. Yet a string of profit warnings or lukewarm trading updates from firms such as OCZ Technology (OCZ:AIM), Sandvine (SAND:AIM), ARM, Wolfson Microelectronics (WLF), CSR (CSR), ARC International (ARK), Sepura (SEPU) and, i-mate (IMTE:AIM) have reminded investors of the harsh lessons learned during the 2001-2003 technology bear market.

Investors should never assume a new technology will instantly enjoy mass adoption. A new product will always encounter competition from the entrenched incumbent product and also user scepticism, as established working practices or favourite gizmos are challenged. I-mate has struggled to establish its Ultimate range of smartphones as serious rival to Research in Motion’s (RIMM:NDQ) BlackBerry.

Dependence upon one particular customer should also be a warning signal. CSR’s shares hit a three-year low last month after the chip designer’s latest warning, which was largely blamed on loss of market share at the firm’s largest individual client, Nokia (NOK:NYSE).

Most importantly, investors should not assume demand for technology gadgets is immune to the economic cycle. OCZ blamed softness in the UK PC market for its third profit warning in barely 12 months, which would have hardly come as a surprise to anyone after the wretched trading update from electricals retailer DSG International (DSGI) which had just preceded the PC component expert’s profit alert.

Technology is therefore not the secular growth engine it always looks, and all of the five best performing tech stocks of the past month (see Table 2) are simply recovering from previous alarming swan-dives.

That is not to denigrate the importance of last week’s A$2.5 million licensing deal to computer imaging expert Seeing Machines (SEE:AIM), but the fledgling Aussie firm has still yet to record a profit since its December 2005 flotation on Aim.

Some tech firms are delivering the goods, though, and a good example if broadband equipment specialist BATM Advanced Communications (BVC). The Israeli firm bears all of the hallmarks of a tech firm going places, such as a strong organic growth, cutting edge technology in a growing market and a net cash balance sheet. Dr Zvi Marom’s firm remains one to follow for the rest of 2008 in a sector which otherwise looks one to still treat with extreme caution.

Shares says:

BUY BATM Advanced Communications

HOLD ARC, CSR, OCZ Technology, Seeing Machines, Sepura

AVOID Wolfson Microelectronics