It’s in the nature of technology that things never remain the same. That includes how you should invest in the sector.
So what better time then to review your strategy then after the new year.
A portfolio stocked with the big-name players—Microsoft, Intel, Dell , Cisco —used to be a good bet, but investors need to be more selective in their holdings—especially after the S&P 500 Technology Index underperformesd the S&P 500 in 2010 (9.6 percent vs. 12.8 percent.)
"A lot of things that worked a cycle or two ago, their growth rate is getting more mature,” says Charlie Chai, manager of the Fidelity Select Technology Portfolio .
Analysts and fund managers believe there’s one trend in its early stages that could provide a boost to several sectors within tech. So for investors looking to reallocate their tech portfolio for long-term growth, it’s all about the network.
Optimized for Growth
Analysts point out that the explosive growth in network connectivity is driving demand for a new wave of technologies. Not only are more people connecting to the Internet, they’re connecting on a variety of devices: PCs, smartphones, tablets, and other consumer electronics devices.
Also, companies—and to a lesser degree, consumers—are relying more on the cloud to store and manage their data, further increasing network traffic. Add to that Internet-connected machines such as smart meters and the amount of data traffic will explode.
“It used to be about speeds and feeds,” says Barry Mills, manager of the Dreyfus Technology Growth Fund. “Now it’s about efficient application delivery. The growth rate in traffic from data center to data center is growing faster than what you’re seeing between client and server.”
That’s why Brent Bracelin, senior research analyst at Pacific Crest Securities, says traditional data networks are in for a multiyear overhaul, providing a long-term growth opportunity for investors.
“If you look at the video workloads that are being deployed today, and at virtual workloads enabled by virtualization, and at cloud workloads, the network wasn’t built to support those types of workloads,” Bracelin says. “The network needs to not only connect devices, it needs to know what device is connected, what’s the speed, where from a location standpoint a device is connected. There’s a whole new wave of intelligence added so that the network needs to answer who, what, why, where, and when.”
Bracelin says companies poised to benefit from this trend include F5 Networks, Riverbed Technology , Juniper Networks , Ciena , and Broadsoft.
Although he cautions that a lot of optimism has already been priced into many of these stocks in the short term, Bracelin believes the long-term outlook for companies involved in data network optimization remains strong.
“Less than 10 percent of the networks globally are optimized,” Bracelin says. “As we use more cloud and virtual workloads, optimization becomes an even higher requirement. The question is, how big can a company like Riverbed be? What percentage of networks will use optimization technology? It’s clearly a big market, but what’s the earnings power of the company potentially two, three, four years from now? That’s the way you have to look at these companies.”
Up in the Cloud
The move to cloud computing is helping drive the need for a more intelligent network infrastructure. It also provides a boost to related industries, including storage, mobility, and virtualization.
“As more applications move to the cloud you need to have more storage behind it,” Mills says. “That’s good for traditional storage providers.”
Kim Caughey-Forrest, senior analyst at Fort Pitt Capital Group, notes that EMC is particularly well-situated to capitalize on the storage front.
Closely connected with cloud computing is mobility. As more corporations move their applications to the cloud, the less reliant they’ll be on traditional PCs and servers, enabling workers to use a variety of portable, lower-power devices.
Because of this, both Mills and Chai expect smartphones and tablets to steal market share from PC manufacturers. Additionally, companies that provide cloud-based software that are accessible on a variety of devices, such as Salesforce.com , will continue to disrupt the traditional software delivery model.
“The old client-server PC model, the legacy way of doing applications and business intelligence, are increasingly losing share to the new waves of technologies,” Chai says. “In some cases they’ll be cannibalized by the new computing paradigm.”
But Caughey-Forrest cautions against dumping the traditional PC companies just yet. For one, corporations are entering a PC refresh cycle, and demand is still growing in emerging markets. Furthermore, she says many PC companies are capitalizing on new computing trends.
“They’re also benefiting from virtualization—getting rid of old power-consuming servers and condensing them into one physical unit,” Caughey-Forrest says. “Dell , HP , and IBM all benefit from this.”
(Editor's Note—Disclosure: Fort Pitt Capital Group owns EMC and INTC as part of the Fort Pitt Capital Total Returnmutual fund.)