8 future tech-stock rockets

By Jim Jubak

So where's the buzz, the fizz, the flash, the dazzling profits in tech stocks?

Certainly not in the big names that you remember from the 1990s that would reliably rocket upward on 25% or better earnings growth year in and year out. These stocks look downright ordinary these days.

The potential rockets, I'd argue, are companies doing business in what are now emerging niches in the technology market. Right now they're small in revenue with products that still haven't met wide adoption. And they face the very real possibility that, once they prove a market, bigger competitors will jump in to steal, if not their thunder, at least their profit margins.

But these companies all have major economic and technology trends at their backs that give them the potential to capture a big share of a future market that now barely exists. No one column can capture all of the trends that could produce tomorrow's big technology markets. But today I'll describe three trends and give you the names of eight companies hoping to capture a share of those trends. Using these examples as templates, you can then go looking for more technology trends -- and stocks to ride them -- on your own.

Maybe the best way to start a search for the next generation of technology rockets is to look at what's happened to the last generation. It's not that you can't make money in the technology sector these days. It's just that the big-name tech stocks seem increasingly similar to stocks in any other sector. The same strategies work for investing in a Microsoft (MSFT, news, msgs) as for a consumer products company like Procter & Gamble (PG, news, msgs). So, for example, if you'd played the new-product-upgrade cycle with Microsoft in anticipation of its new Vista operating system set to go into general sale in early 2007, you'd be up 11% in 2006 (through Oct. 31). If you'd played the same trend with Procter & Gamble, betting that putting the company's marketing muscle behind newly acquired products from Gillette would produce a big jump in sales, you'd be up the same 11% in 2006. (Editor's note: Microsoft is the publisher of MSN Money.)

Similarly, if you want to make money by investing in Intel (INTC, news, msgs), treat it as a cyclical -- just like an oil driller like Transocean (RIG, news, msgs) or a machinery maker like Caterpillar (CAT, news, msgs) -- and buy when sales slump at the bottom of the cycle and sell when they soar at the peak.

Or make your profit by dollar-cost averaging into the steadier 12% earnings growth of Cisco Systems (CSCO, news, msgs) by buying more shares on weakness and fewer when the stock peaks. That's the same strategy you'd use with a PepsiCo (PEP, news, msgs), which is forecast to grow earnings by 13% in 2006 and 10% in 2007. That's roughly the same kind of growth Wall Street is looking for from Cisco Systems in that period.

Why tech stars lose their sparkle

So why does this last generation of tech stars seem so much less stellar now?

• They got big. Real big. It's hard to keep growing by 25% a year when sales are $28.5 billion annually (Cisco Systems) or $45.4 billion (Microsoft). A big sales success in a small new market isn't going to get the job done. You need a big success in a big market -- and there just aren't a lot of opportunities like that around.

• Competition went from hot to white-hot. Competition in the technology sector intensified as a result of the tech revenue crash in 2000-2003, competition from China and the very short lead time it takes the global supply chain to clone a fast-selling product. That put the pressure on and kept it on margins. A relentless cost-cutter with huge market clout like Cisco Systems runs as fast as it can to stay in place: Because gross margins have slipped (to 65.8% from the five-year average of 67%), all that cost-cutting has basically just kept net profit margins level (at 19.6% in the last fiscal year, close to the five-year average of 19.2%). Technology companies have always had their maximum ability to raise prices after a new product is introduced: That window is much narrower these days.

• They became mature. PC hardware and software. Internet servers and routers. Database software. Wireless phones. All these are now mature markets where companies can keep selling more units only if they add lots more power and features at the same or lower prices.

To find the new rockets, then, just invert these characteristics: Look for small, immature companies in markets that are so new that the price premium on a new product is very high and has the potential to last longer, since the big companies with their advantages of scale haven't yet put a foot into the market.

3 niches investors should watch

Here are three technology niches that fit that bill in my opinion.

1) Batteries: better things in smaller packages

There are two takeaway lessons from the fires that forced Dell (DELL, news, msgs), Apple Computer (AAPL, news, msgs) and Toshiba (TOSBF, news, msgs) to recall almost 10 million lithium-ion batteries.

• Current battery technology has hit a wall. Lithium-ion battery technology, the technology of choice at the moment since it combines high power, fast recharge and steady voltage, is now 30 years old and it is showing signs that it can't meet the relentless demands from consumer electronics makers and customers for more and longer lasting power in smaller and smaller packages. As more and more powerful lithium-ion batteries are squeezed into smaller and smaller packages, the likelihood that batteries will overheat and burn increases.

• The demand for battery power for mobile devices is huge -- and growing. Lithium-ion batteries alone powered 50 million laptops, 800 million cell phones and 80 million digital cameras sold in 2005. And this doesn't count the lithium-ion and older nickel-cadmium batteries in use in devices such as cordless power tools.

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