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  • June 16, 2011

    Not since the Internet craze of the late '90s have technology investors shown the ardor generated by the latest wave of social media, e-commerce, and other digital companies blooming on the increasingly ubiquitous Internet.

    • Sparked by the introduction of the iPhone four years ago, the convergence of computing and communications is not only changing lifestyles and spawning dynamic new companies, but also providing new growth opportunities for established industry leaders.
    Unlike the dot-com bubble, which burst in March 2000, these new trendsetters generally have far more viable business models, and some have grown rapidly.
    • They are capitalizing on the growing capacity of wireless networks to support expanding mobile communications—trends that have enabled a new era of innovation.
    • In contrast to the last Internet boom, "the profitability or potential for profitability is already there," says David Eiswert, lead manager of the Global Technology Fund.
    Indeed, the sudden success of these companies is fulfilling the early promises of the Internet.
    • "What we're seeing now is what fueled much of the optimism and ultimately much of the speculation in the 1990s," says Robert Sharps, a large-cap growth manager.
    The new media have already marked some impressive milestones:
    • In just seven years, a social networking company has amassed more than 600 million users.
    • An online messaging service and microblogging company has accumulated 175 million registered users in just four years.
    • One company's smartphone has sold roughly 100 million units in four years, while another's operating system for mobile phones is activating users at a rate of 300,000 per day.
    With some of these companies expected to go public within the next year or two, there already are concerns about another potential Internet bubble.
    • "Not all of these companies are going to be winners," cautions Anna Dopkin, co-director of T. Rowe Price's North America equity research. "However, with extensive research and analysis, you can increase the likelihood of determining which ones will be successful and which ones will likely fall short."
    • Sharps adds: "We can't say whether the valuations of these private companies are reasonable or not. Some may be overvalued based on the hype surrounding all this. But based on the strength of positioning of some of these firms, there is a reasonable chance that they can become much larger companies over time."
    • Paul Greene, a T. Rowe Price media and Internet analyst, cautions that some companies "are getting a lot of venture capital funding and don't have a lot to show yet. But some of these companies have real business models, are growing very fast, and their valuations don't seem anywhere near what some companies reached in the 1990s."
    Companies with dynamic growth opportunities can grow into what seem to be excessive valuations at the time.
    • "The question is, what is the potential for these companies longer term," says Dan Martino, lead manager of the Media & Telecommunications Fund. "Good growth investors stick with companies that are well positioned even when the valuation appears to be full, and that takes a lot of courage, research, and experience."

    Growth stocks tend to be more volatile and can have sharp price declines due to earnings shortfalls.

    T. Rowe Price managers are sticking with leaders.
    • Some T. Rowe Price funds have made small investments in a few of these private new media companies, recognizing their potential growth.
    • The firm's technology strategy, however, remains focused on industry stalwarts, which are driving change and benefiting from new opportunities.
    T. Rowe Price believes that cloud computing and mobile communications are the two dominant trends in technology today.
    • "Cloud computing is more about companies and mobile communications is more about individuals," Ken Allen, lead manager of the Science & Technology Fund says, "but they tie together because a lot of what we do on smartphones and tablets relies on cloud computing. Without these data centers in the cloud, you could not do as much on your smartphone."
    • T. Rowe Price managers are also finding attractive opportunities in a range of infrastructure companies and component manufacturers that serve the wireless community.
    • There are more opportunities in emerging markets, especially Asia, to invest in such companies because of the rapid growth of consumer classes in India and China.

    Investments in emerging markets are subject to abrupt and severe price declines and should be regarded as speculative.

    The changing technology landscape is unfolding at such speed that fund managers say vigilance is in order.
    • While closely tracking these new digital companies for potential opportunities, they also are watching out for possible threats to established leaders.
    • "No one is immune to the effects of rapid change," Sharps observes. "The odds are that some of these leading companies will continue to take advantage of the magnitude of this change, but the pace of change suggests they have to anticipate and be highly innovative…it would be foolish of us to think we are going to go through this period of innovation right to maturity just riding existing companies."
    • Eiswert concurs. "This is a great time to be a tech investor, considering the potential opportunities," he says. "Five years ago people thought tech was dead. And that may be true for some parts of it. But for other parts we're just at the beginning."

    For a more detailed discussion, see "A New Era of Internet Investing" in the Spring 2011 Price Report.

    Investing in technology companies involves special risks, including earnings disappointments and intense competition for market share, that can result in sharp price declines.

    Copyright 2014, T. Rowe Price Investment Services, Inc., Distributor. All rights reserved.