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at the bell

With the collapse of Nortel and the fall from grace of former market darling Research In Motion, the Canadian tech sector has almost vanished as a top-of-mind idea for investors.

But tech stocks have quietly made a comeback, recently emerging as the unexpected hot spot in an otherwise lacklustre domestic equities market.

Among the larger names, CGI Group Inc., Open Text Corp. and Constellation Software Inc. are all on a tear, with gains that have smoked most of the rest of market. Even more noteworthy, CGI, which provides information technology to companies and governments, has overtaken Research In Motion for the mantle of the country's most valuable technology company in terms of market capitalization.

Clarus Securities, in a bullish report last week on the sector, highlighted the eye-popping gains among tech names that have focused on growing through acquisitions. In the past year, CGI has risen 55 per cent, Constellation 64 per cent and Open Text, the Waterloo-based data management company, 38 per cent.

Clarus expanded its list of consolidators to include two more names – Catamaran Corp. and Davis + Henderson Corp. – and calculated that the average five-year compounded growth rate for the five companies clocked in at 30 per cent.

The huge gains are a sign tech is back and that Canadian investors don't need to go to the U.S. to find decent opportunities for profits in the sector.

But given the huge increases, you might think there would be a note of caution creeping into the market. Many of the tech names have baggage that suggest a bet on them may not always be a one-way street. CGI, for instance, issues large numbers of options to executives and must divert cash flow for share repurchases to keep its stock count from surging. The hottest tech companies in Canada are also serial acquirers, a strategy that has integration risk.

But many market players – both the sell-side analysts at the brokers and buy-side players at portfolio managers – don't yet see frothy enough conditions to convince them it's time to take a lot of money off the table.

At Donville Kent Asset Management, the firm has about a third of its assets in three tech companies: CGI, software maker Enghouse Systems and Constellation.

"We've got a pretty big bet on technology," says president Jason Donville.

Mr. Donville still likes selected names in the sector, particularly CGI and Constellation, which he says are inexpensively priced, although he admits that it is "certainly getting harder to find bargains."

A few years ago, value was so commonplace "it was just like shooting fish in a barrel. It was very, very easy to find good, cheap stocks," he says.

Some stocks have moved beyond Mr. Donville's buy point because they are no longer cheap relative to their earnings power. Among them are Enghouse and Descartes Systems Group, which he calls "great companies [that] look really expensive right now."

(The view on Descartes being pricey isn't shared on the sell side. Both Stifel Nicolaus and Cantor Fitzgerald recently issued bullish reports calling the company a buy, after it reported strong first-quarter earnings.)

Why the tech boom? There may be a Canada-specific reason.

Portfolio managers say fears that the commodity era is ending have prompted many Canadian investors to look around for alternatives. Technology companies seemed a logical choice. Their valuations crashed with the rest of the market after the panic, yet their prospects for growth still seemed decent.

"The reality is there is a flow of Canadian money away from resources," says Peter Dlouhy, portfolio manager at Lester Asset Management in Montreal. Lester has two tech names in its top holdings, Open Text among the large caps and patent licensing company Wi-LAN Inc. among the small caps.

The view that Canadian techs may still be undervalued is bolstered by the high number of recent acquisitions. Clarus listed 14 companies – names such as Gennum, Mosaid and Zarlink – that have disappeared in the past three years. The deals were done at an average premium of 51 per cent over the share prices before the acquisitions.

Alas takeovers are bittersweet.

"Thinking about the next potential takeout candidate is a common theme for Canadian technology analysts as it has become a recurring discussion point with clients. While finding these takeout candidates can be rewarding with a one-time acquisition premium, over time it removes a significant layer of potential growth companies from the Canadian landscape and leaves us searching for the next great growth story," Clarus says.