Wiring Your Portfolio for Tech

Long gone are the days when all you had to do was hear the word technology or Internet and you knew you had a hot stock pick.

Investors have learned a valuable lesson since the tech bubble burst in 2000 and the Nasdaq lost two-thirds of its value.

Nasdaq

“You can’t just throw money at the technology wall,” says Bruce McCain, head of strategy at Key Private Bank’s investment-management unit in Cleveland. “You’ve got to make sure that you’re playing the trends that are producing growth within technology. Be much more selective.”

And remember: Tech is still a risky business.

“Investors have to constantly be vigilant with respect to what is high tech today could be low tech -- or no tech -- tomorrow,” says Hank Smith, chief investment officer at investment-management firm Haverford in Philadelphia.

McCain suggests keeping the tech part of your portfolio between 12 and 22 percent, based on the fact that tech companies represent 17 percent of the S&P 500. His firm typically has about seven to ten tech positions in a portfolio of 30 to 50 stocks.

But don't bet too big on any one of them. A good rule of thumb is to not have any more invested in one company than you can afford to lose. A lot of money managers peg that at 10 percent, though 3 percent is probably a safer bet.

Attractive Valuations

So, which criteria should you use when selecting tech stocks? Big sell-offs produce attractive valuations -- can you go on valuation alone?

“Valuation only enters our process after we have decided that we thoroughly like the business,” says Pip Coburn, founder of Coburn Ventures and a former global technology strategist at UBS. “Then we ask what the price is. It’s like when you go shopping -- you look for clothes you would like to wear and then see if the price works for you.”

You’ve got to do your homework, strategists say, and really know what the company’s promising, what its long-term potential is relative to competitors and how financially stable it is.

That’s still the single, biggest mistake investors make when it comes to tech -- jumping in when they haven’t done their research, Coburn says.

Chris Orndorff, head of equity at Los Angeles money manager Payden & Rygel, offers these three criteria for choosing a tech stock:

1) Earnings Growth. -- “Not revenue, not clicks, but earnings growth -- over a three-year period,” Orndorff says.

2) Global Appeal -- “That’s more important than ever,” Orndorff says, given the slowdown in the U.S. “You don’t want a product that has a narrow appeal.”

3) Financial Flexibility -- You want to look for cash on the balance sheet, Orndorff advises. “What this market has shown us is that companies like Apple and Microsoft that have been accumulating cash -- that was an extremely wise decision,” Orndorff says, “because access to capital markets … is essentially broken right now.”

Set Your Watch

Glance at your investments every week to “make sure nothing is falling out of bed with you,” McCain advises.

Take some time twice a month to do more in-depth research. Spend half of that time looking at your asset mix, advises Jack Ablin, chief investment officer of Harris Private Bank in Chicago. Spend 30 percent of that time looking at opportunities for growth in the next year and the last 20 percent on sector analysis or, if you favor funds, manager performance, Ablin says.

McCain advises setting up a comparison of your individual tech-stock investments against a reasonable alternative, like the Technology SPDR (XLK), an exchange-traded fund, over a six-month period. If you’re outperforming it, then, great. You’re adding value. If not, McCain says, better to collapse it back into the fund.

A good starting point, McCain says, is to put three-quarters of the money you’ve allocated for tech into an ETF like XLK, then buy two individual stocks of about 3 percent each. If you do well, add another 3 percent.

Be careful when choosing what sectors to invest in. Outlooks from Cisco , Oracle and other tech bellwethers have shown that tech isn’t immune to business cycles.

Demand for hardware and software may falter during economic downturns and you might want to stay away from equipment makers. “Any cycle tends to be magnified for them,” McCain says.

Sectors with encouraging outlooks include Internet (particularly companies focused on Web-video technology), wireless technology and data storage.

The Next Big Thing

So, what do you do if you’ve got some extra cash burning a hole in your pocket and you hear of a product you think will be the next, big ubiquitous thing -- the next BlackBerry?

“Be very, very, very suspicious,” says Coburn, who is also the author of, "The Change Function: Why Some Technologies Take Off and Others Crash and Burn."

“Never try to hit home runs,” adds John Massey, portfolio manager at AIG SunAmerica Asset Management in New Jersey. “Do your research. Take steps. Make an investment and continue to do work … dollar-cost average as you go along.”

Coburn cites Warren Buffett, who took a lot of ribbing in the late 90s for not getting in on the tech boom, and his common-sense approach: Don’t invest in things you don’t know.

And, Coburn stresses, tech isn't for the faint-of-heart, either.

“The parallels between tech investing and gambling in Las Vegas are only too apparent," Coburn says.

© 2008 CNBC.com