2015 Investor’s Guide: Don’t buy this, buy that—Technology and Biotech

December 4, 2014, 12:00 PM UTC

Sometimes the smartest actions are the ones you don’t take. That old dictum seems relevant at a moment when the markets are a paradox: Each new high only makes many veteran investors more nervous that disaster looms. Between lofty valuations, slowdowns from Europe to China, conflict from Ukraine to Syria, the end of the Fed’s bond-buying binge, and more, there are many reasons for caution. That’s why this year we decided to recommend not only investments to make but also ones to avoid. Smart defense is always wise, and the good news is that even in these precarious times, there are still opportunities to be found.

Newly public tech companies have been all the rage in 2014, particularly social media and those that operate “in the cloud” and have equally wispy profits. “I’m not saying the market is where it was in 1999,” says David Rolfe, who manages $10.5 billion for Wedgewood, “but some of these companies aren’t that far away.” He says he’s “treading very carefully.” As he puts it, “‘Cloud’ is a buzzword. We ask ourselves: Are they making any money at it? Many aren’t.”

BUY2-young techSources for all graphics: Dealogic; Bloomberg; S&P Capital IQ; MSCI; Everest Capital

Rob Taylor, co-manager of the $29 billion Oakmark International Fund, also eschews cloud software companies “and some of the other pretty highflying stocks right now,” like Workday (WDAY). (The company, which isn’t currently profitable, trades at 1,656 times projected 2017 profits.) Meanwhile, he prefers Oracle (ORCL), which has a database business and cloud revenue, for just 13 times next year’s estimated earnings. “It’s just an example of people looking at the newest and greatest and getting attracted to that almost irrespective of valuation, and Oracle is almost forgotten,” he says. Rolfe is bullish on old-school American giants such as Qualcomm (QCOM) and Apple (AAPL), whose P/Es are only 14 and 15, respectively. Margaret Vitrano, who manages $7.7 billion for ClearBridge and Legg Mason (LM), strikes a balance somewhere in the middle, avoiding stalwarts like IBM (IBM) and Cisco (CSCO): “IBM is hardly a growth company, so we think we can do better,” she says. Instead, she owns shares of Red Hat (RHT) and Akamai (AKAM), which provide cloud-computing services to businesses, because they are growing faster—and are profitable. Vitrano sees hope for Microsoft (MSFT) because among big companies, it’s “best positioned to still be relevant in a world that’s moving to cloud,” she says.

It may have been the hottest IPO of the year—not to mention one of the biggest in the history of U.S. stock exchanges. But at around $113 per share, Alibaba (BABA) trades at nearly 50 times next year’s expected earnings, even while U.S. investors are still learning the ins and outs of the Chinese company.

Oakmark’s Taylor is also clicking past Alibaba in favor of a more familiar Internet leader: “We can own Google (GOOG) for less than half the multiple of Alibaba—and it’s not based in China,” he says. “It’s a great company with a big moat and a much cheaper valuation.”

BUY3-young tech 2Sources for all graphics: Dealogic; Bloomberg; S&P Capital IQ; MSCI; Everest Capital

Of late, small biotech stocks have offered soaring reward—and even more epic risk. Investors have cashed in on giant gains in one tiny biotech just to see another one plummet after its only drug failed to win FDA approval. “We do think people should be taking profits in health care, particularly in pharma and biotech,” says Citi’s Levkovich. “Biotech stock valuations are particularly discomfiting. They’ve become very expensive. Historically, when you get to this kind of level, it’s poised for underperformance.”

Medicine is still in an exciting age of innovation, and Obamacare and the country’s aging population are invigorating the health care sector. Vitrano employs a barbell approach, with certain biotech companies on one side, and on the other, steady names like CVS (CVS), whose pharmacies and drug-distribution businesses should find a tonic in the aging U.S. population. Two of Vitrano’s top-five holdings are diversified biotechs Celgene (CELG) and Biogen Idec (BIIB), which are investing heavily in research and development and therefore “are not so dependent on binary events like a drug getting approved or shot down by the FDA,” she says. A single drug currently accounts for more than 60% of Celgene’s revenues, but Vitrano says the company has made several acquisitions and is feverishly working on new products to inject diversification. Oppenheimer chief market strategist John Stoltzfus prescribes a dose of iShares Nasdaq Biotechnology ETF, whose top holdings include Gilead (GILD) and Amgen (AMGN). He supplements his core holdings in that ETF with a “satellite approach,” buying shares of those two individual names.

BUY6-biotechSources for all graphics: Dealogic; Bloomberg; S&P Capital IQ; MSCI; Everest Capital

Read more from the Fortune 2015 Investor’s Guide “Don’t Buy This, Buy That” series:

Consumer Stocks
Stocks, Bonds and Funds
Energy and Mining
Real Estate and Industrial Stocks
Foreign Markets

This story is from the December 22, 2014 issue of Fortune.

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