I really don't understand the recent PE shrinkage.
Seems to me that the market has decided to really discount forward earnings projections in this sector. Most analysts in the sector seem strongly bullish on the stocks they follow, and I think for good reason. The rapidly expanding globalization of ECM in Europe, Asia, and Latin America is one factor, and in the US, the ECM companies are picking up additional responsibilities from the OEMs, like routine design, and material procurement etc. I still think the long term growth in this sector will exceed 25% over the next five years. By my estimate, stocks like FLEXF and DIIG are trading at about 14 times next years earnings. In the case of FLEXF, it sells at less than 50% of next year's revenues; and CEO Micheal Marks is sitting on over $100M in cash that he can use to expand sales further. Both FLEXF and DIIG should see 30% growth or better longer term beyond next year. JBIL is trading about 18 times my estimate of next year's earnings(I think the analyst numbers are low), but given Jabil's close ties to premium growers like Cisco, 3Com, and Quantum, that multiple doesn't seem out of line. Based on what I've heard, just the added business expected from those three will generate a terriffic growth rate for Jabil.
If we discuss PEs, we need to really compare to the S&P multiple and the interest rate on ten year treasury bonds. Current ten year Treasury bonds at 5.86% are yielding an equivalent PE of 17.0 for flat earnings (no growth) over a 10 year period. The current S&P mulitiple is around 23.54 (quoted in today's WSJ article called "The New Math: Are Some High P/E Stocks 'Bargains'?"). If the S&P earnings grow 7-10% next year, then the forward PE is about 21-22.
So we see a PE of 17 for no growth (albiet low risk) for treasuries, a PE of 22 for 7-10% growth for the S&P500, then the PEs of 13-20 for leading ECM stocks seems awfully low for the 25-30% growth these stocks should see.
I really think this sector sold off based on some individual stock problems (like ACTM) and because the leading stock(Jabil) in the sector had simply run so far so fast. When Jabil sold off, it took the whole sector PE down with it. Jabil's sell-off was based on profit taking, some cautionary remarks from the CEO to expect only 30% growth as a reasonable long term target (which I think he expects to exceed easily), the market was scaling back growth projections for the networkers and data storage stocks, and the stock market as whole and tech stocks specifically took a big hit in October and early November. Jabil's sell-off was peppered with a few relativley small insider sales in the narrow window they can sell (and they have sold similar or larger amounts in similar windows over the last several years), and by the fact that several "so-called" technical supports were broken.
Personally I don't think the long term bull case for Jabil has been diminshed much if any. They should report significant revenues and earnings growth over the next 12 months based on recent expansions coming on line. Beyond the next 12 months, the expansion and new product growth plans of their major customers gives an longer term growth rate well above 30%. But let us just use 30% long term. The stock is not overpriced at a PE of 18-20. The recent run-up in the stock price was based primarily on margin growth, and the market now expects the margin growth to flatten. But when the company starts to report the strong revenue growth, and undiminished earnings growth exceeding 30%, I think the current PE will be viewed as "cheap" for this stock.
I think we might be getting toward the end of this sell-off. I think sometime late next week, Solectron will report earnings and show strong sequential revenue growth of 8-10% or better after only 6% sequential growth last report. The following week Jabil reports, and again I think they will report good sequential revenue growth of 7% on top of good sequential growth last quarter. Both conference calls should report expectations of increased revenues in the next quarter and over the next year due to recent acquisitions or expansions coming on-line (both have new Mexican plants, for example).
In a low inflation low interest rate environment, the market will increasingly focus on companies that can grow earnings in that environment without a big risk of earnings decreases. And I think that the companies in this sector fit that bill. The market will be lookng especially for stocks where the top line growth(revenues) are good, so investors won't have to worry as much about a margin squeeze.
So if Solectron and Jabil report good sequential revenue growth in their reports over the next two weeks, I think we have seen the bottom for the sector. If their PEs climb, the rest of the sector will follow. Personally my favorites are DIIG and FLEXF, but if SLR and JBIL lead the way, I won't be disappointed.
Paul |
