Tech Stocks: 2 to Avoid, and 1 to Buy

Technology has revolutionized the world. Source: Flickr.

The technology industry has done quite well lately, carrying the Nasdaq Composite back up to the 5,000 mark for the first time since the turn of the millennium. Yet even though many tech stocks have performed well lately, some are facing major challenges that might make some investors reluctant to commit their hard-earned capital.

In order to pinpoint a couple of troubling tech stocks and a solid alternative to recommend, we asked three Motley Fool contributors to give their thoughts on some well-known companies in the technology sector. Look at what they have to say and see what you think about both their bullish and bearish views on these companies.

(Advanced Micro Devices): It may seem tempting to buy shares of Advanced Micro Devices in the hopes of a turnaround, but it's one stock that I'd stay away from. The company's core PC business, which includes PC processors and graphics cards, has been unraveling for the past few years, and its attempts to diversify away from the PC has spread the company's limited resources too thin.

Source: AMD.

Despite high-profile new product launches in recent years, AMD has been bleeding market share to both Intel in the CPU market and NVIDIA in the GPU market. A few years ago, AMD shipped about 40% of all discrete graphics cards; today, this percentage has fallen to just 24% as NVIDIA has consolidated its lead. AMD plans to launch new graphics cards later this year, but the most recent refresh of its product line didn't help in terms of market share at all.

AMD has managed to stay afloat thanks to its deals to provide the processors for the major game consoles, and the company is actively trying to strike additional semi-custom design deals. But any profits from this segment have been largely wiped out by losses in the PC segment and significant interest payments on the company's debt. With any future semi-custom deals unlikely to be anywhere near as big as the game console deals, meaningfully growing the segment will be difficult.

AMD is a company that's trying to compete in too many markets: PC CPUs, GPUs, server CPUs, semi-custom CPUs, and embedded CPUs. Intel spends more than ten times as much on research and development compared to AMD, and even NVIDIA now outspends the company on that front. AMD needs to narrow its focus, and until that happens I can't recommend the stock.

Dan Caplinger (Nokia): One stock I would avoid currently is Nokia , which is only a shell of itself after having sold off its mobile device and services division to Microsoft last year. It's true that the sale helped Nokia rid itself of what had become an unsuccessful business, as the mobile phone pioneer had failed to keep up with the rapid pace of innovation in the sector and was under threat from more aggressive smartphone makers around the world. What's left is a trio of businesses, with its networking products producing the bulk of Nokia's remaining revenue.

The big issue facing Nokia is whether it can successfully make the transition in an increasingly competitive networking environment. Opportunities abound for growth, especially in the lucrative U.S. market. But the possibility of a dividend cut looms large over Nokia, and even with the stock at relatively reasonable valuations, any reduction in its dividend payout could send the share price tumbling. Nokia will need to demonstrate its ability to tap into important trends like the 5G upgrade cycle while keeping its margins as high as possible. In the long run, Nokia could very well end up on top, but right now, I'd prefer to see how the competition lines up before making bets on the sector.

(Microsoft): Microsoft is a tech stock investors should buy, because it provides a great combination of growth, value, and dividends, meaning the stock has something to offer virtually all investor types.

Microsoft's two core operating segments, commercial and consumer, both grew revenue last quarter. Devices and consumer revenue grew 8% to $12.9 billion due to several factors. Microsoft sold 10.5 million Lumia units last quarter, leading to $2.3 billion in phone hardware revenue. Surface revenue grew 24%, driven by the success of the Surface Pro 3. Office 365 Home and Personal subscribers jumped 30% to over 9.2 million. Even Bing contributed positively as search advertising revenue rose 23%.

Microsoft's other big business is doing well too. Commercial revenue increased 5% to $13.3 billion thanks squarely to Microsoft's booming enterprise cloud business. Commercial cloud revenue soared 114%, thanks to Office 365, Azure, and Dynamics CRM Online, and eclipsed a $5.5 billion annualized revenue run-rate. And revenue from server products and services grew 9%.

In all, Microsoft generated $9.9 billion of free cash flow in the first half of its current fiscal year. It paid $4.8 billion of dividends in the same period, which equates to a very comfortable 48% payout ratio. All this cash is piling up on the balance sheet. At the end of last quarter, the company held $90 billion in cash and marketable securities on the books with just a 20% long-term debt to equity ratio.

Microsoft produces huge free cash flow, returns a sizable chunk of it to investors through its 3% dividend, and trades for just 16 times earnings. For all these qualities, Microsoft is a buy.

The article Tech Stocks: 2 to Avoid, and 1 to Buy originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. Dan Caplinger has no position in any stocks mentioned. Timothy Green has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.