Tech Spending Is Up: Skip Dell, HPQ, Buy These Stocks Instead

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Forbes.com, Winter, 2012. This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

In case you haven’t been watching, tech spending is on the upswing. According to IDC, the giant technology intelligence firm, tech spending rose 5% in 2011, and is expected to rise another 5% in 2012.

Tech spending was gathering steam until 2006, when things went south, and stayed that way until it actually went negative–i.e. contracted about 5% in 2009. It’s been on the rise since, and this is good news for investors.

I think the way to play this trend is by investing in what is known as the “data center.” The data center isn’t on the front lines where technology is used, but rather in the back where it is managed.

This explains my investments in EMC (EMC) and Cisco (CSCO). Specifically, rises in tech spending often disproportionately benefit companies selling into the data room. That’s because the implementation of a higher tech spend generally has two prerequisites: more networking gear and more memory.

EMC is a global leader in helping companies store, manage and protect their information. Meanwhile CSCO is a leader in communications and networking equipment.

So while overall tech spending is projected to be up 5%, I feel confident that networking and storage will grow almost twice as fast at 8% to 10%.

Moreover, the margins that can be earned on storage and networking products–40% to 60%–are much higher than the more commoditized computing elements of the data centers, which might top out at 30%. That’s why you won’t see companies like Dell (DELL) and HP (HPQ) in the portfolio. They are running in place in their server businesses.

Margins are high right now because there’s a lot of new technology surrounding the use of flash memory and virtualization. The entire architecture of the data center is being reconsidered, and so there’s not only room for growth on a bigger tech spend, but possibly explosive growth on the heels of new innovations.

However, innovation can have an ugly side too: it’s called disruption. The kind of paradigm shift no one saw coming. To me that’s a bona fide risk, but one that for now is held in check, and a good reason for investors to be in the data center.