When Opportunity Knocks Again
I goofed when I first passed on Lucent, Sun, and Qualcomm. Here's what I've learned from those
mistakes.
By Jim Jubak
Buy the wrong stock and the market forces you to confront your mistake every time you
pick up an account statement or check a quote. Right now the market is rubbing my face in
my purchasing errors. Why, oh why, did I buy oil-service stocks, or Ascend Communications
(ASND), or ... ? You can fill in the blanks for me.
But the market won't remind an investor nearly as forcefully of another kind of miscalculation
-- what I'd call an error of omission. During the last year, I've decided not to buy some stocks
as well as to buy others. Some of those decisions not to buy have actually cost me just as
much money as the worst of my purchases. I decided not to buy Qwest Communications
(QWST) last summer near $30 -- it currently trades above $70. I passed on Pfizer (PFE) when
it dipped to $53 last summer -- now it trades near $80. I remember arguing in my column that
Gillette (G) was too expensive at $80. It's now slightly over $100, back near its 52-week high.
Most investors spend at least some time trying to learn from their stock-buying errors; I'll
tackle how you learn from that kind of error, using my own mistakes, in a column to come.
But I think you can learn just as much from your errors of omission. Figuring out why you
couldn't see a stock's virtues will teach you how to make more money in the future.
And this sort of navel-gazing has one important advantage over the painful study of why you
bought a lousy stock. Sometimes the market actually gives you a second chance to buy a
stock that you passed up months ago at the same or even a lower price.
The current painful market is full of gifts like that. Let me use the example of three stocks:
Sun MicroSystems (SUNW), Lucent Technology (LU) and Qualcomm (QCOM). I now think I
made a mistake in not buying each of them six months ago. All three are again trading at
attractive prices. And each case teaches a different lesson about a common investing
mistake.
I try to be a long-term investor, but sometimes I take too long a view. I probably ought to
have John Maynard Keynes' famous quote -- "In the long run we're all dead" -- taped above my
desk. Looking too far ahead led me to pass on Sun Microsystems when I should have been
loading up on the stock. In June and again in November, I could have easily picked up all the
shares I wanted at $35. Now the stock's near $45 -- not the bottom, I know, but still well
below the $51 that's the high for the year.
I think Sun has built
earnings momentum
that could push the
stock to $55 in 12
months.
Snapshot
3-Year Chart
Financial
Comparison
Earnings Estimates
I'm convinced that the long-term trend in the computer market is running against the
makers of high-powered and high-priced workstations such as Sun. Certainly, PC-based
servers running NT, the network version of Windows from Microsoft (MSFT), are taking share
and will continue to do so. Even if the current version of NT isn't ready to handle the
toughest networking tasks -- and it's not -- PCs, with their low and still-falling costs and
increasing power, will keep nibbling away at the margins. (Investor is published by
Microsoft.)
In the long run, that spells trouble for Sun. But over the next few years, and perhaps longer,
the trend actually works to Sun's advantage. The workstation industry is rapidly
consolidating, with weaker players -- Silicon Graphics (SGI) is the most recent victim -- losing
share not just to PC makers such as Compaq (CPQ), but to other workstation makers. Sun,
as the No. 1 workstation maker, is the primary beneficiary.
I should have remembered what happened when the first mini-computers from the likes of
Digital Equipment (DEC), and then PCs, ate the mainframe business. Once upon a time,
companies such as Control Data (CDAT), Sperry, Burroughs -- even RCA -- along with IBM
(IBM), all made these heavy-duty computers. The weak sisters merged, divested, or folded.
IBM gained market share.
Of course, IBM went through a tough transition as it cut costs again and again and tried to
adapt to competition with leaner and more nimble startups. But Sun is a much tougher
competitor than IBM was then.
For example, in the most recent quarter Sun raised its gross margins to 52% -- up 2
percentage points from the year-earlier quarter -- as demand for its heavy-duty Internet
servers soared. But rather than sit back and reap the profits from selling expensive
machines while PC servers ate away at the lower end of the cost scale, Sun aggressively
counterattacked last week with its Darwin line of low-cost servers. Sun now has a product
that basically matches the price of NT-based machines. That kind of willingness to cannibalize
its own sales to defend market share is exactly what I want the No. 1 company in an industry
to show me. I think Sun has built earnings momentum that could push the stock to $55 in 12
months.
By my calculations,
Lucent will be a $90
stock in twelve
months.
Snapshot
3-Year Chart
Financial
Comparison
Earnings Estimates
I passed on buying Lucent because of prejudice. Every investor hates a few companies and
despises a couple of CEOs. Maybe you got burned in the stock once before -- I could never
bring myself to buy any company Oracle (ORCL) CEO Larry Ellison runs, for example. Maybe
you've used the product and it's left a bad taste in your mouth; I won't buy Starbucks (SBUX)
because I think its $2-a-cup coffee tastes like swill. (Yeah, I know. Millions of people
disagree. But then, millions of people think Jack Nicholson is a good actor too.)
Some of these reasons are legitimate. Some are ridiculous twitches that cost me money. I
was far into the latter category when I refused to buy Lucent because it was a spin-off from
AT&T (T), my candidate for the worst-managed company in the United States during Robert
Allen's tenure as CEO. I just couldn't imagine that any company Allen had touched could be
any good.
What I should have realized, of course, was that Allen, true to form, would spin off a great
business while hanging onto a mediocre one. Free at last, Lucent has been burning up the
tracks.
Just look at the recent quarter's (the first of Lucent's fiscal 1998) earnings report. Revenue
on continuing operations climbed 16% year to year. Earnings, excluding one-time charges,
soared 43% to $1.72 a share, 19 cents above analyst expectations. Management achieved
this by reducing expenses as a percentage of sales and by improving gross margins. All this
while the company was digesting its acquisitions in voice messaging and data networking.
With new products set to kick in during fiscal 1998, and with the company's solid position in
high-growth industries such as wireless telephony, I see Lucent easily booking the 25%
growth that analysts are projecting for fiscal 1998. By my calculations, Lucent will be a $90
stock in twelve months.
I think this stock
could trade at $75
in 12 months.
Snapshot
3-Year Chart
Financial
Comparison
Earnings Estimates
Once you've
re-evaluated a stock
that you mistakenly
ignored, you
shouldn't just
mindlessly buy it.
I'm actually most embarrassed by my decision to ignore Qualcomm, the last of these stocks. I
did what I urge all of my readers not to do: I made an investment decision based on a market
guru's opinion rather than on my own research.
I'm a big fan of Michael Murphy, the editor of the California Technology Stock Letter, so
when Murphy panned Qualcomm, I took it seriously. Murphy felt that the company's wireless
standard CDMA wasn't all it was cracked up to be and wouldn't be able to compete with the
GSM standard that then dominated Europe. That was good enough for me. So I ignored the
stock as it climbed from around $45 a share in August to near $70 in November.
But a company that beats analyst estimates by 16%, as Qualcomm did in the quarter just
reported, gets my attention -- especially when the company beat analyst estimates by an
average of 10% in the previous three quarters as well. Add the fact that analysts are raising
their estimates on Qualcomm's earnings during a time when they are cutting their
projections at almost every other technology company and the story becomes truly
compelling. I think this stock could trade at $75 in 12 months.
Once you've re-evaluated a stock that you mistakenly ignored, you shouldn't just mindlessly
buy it. You've still got to calculate how the potential risk and return on each stock stacks up
against what you already own and against any other stock you might be considering.
These three stocks, for example, have very different risk/return profiles. In the most
recent quarter, about 12% of Sun's sales came from Japan, a market that still seems to be in
decline. Revenue from the entire Pacific region grew only modestly in the most recent
quarter and could actually show a decline in the upcoming quarters. I have to weigh that risk
against the potential 22% gain if the stock hits my projected target price in 12 months. I'm
leery of the effect of Asia on the price of all technology stocks, so I think I'll hold off on Sun
for the moment -- the upside is attractive but not attractive enough. It goes into my watch
list and not into my portfolio.
Lucent is much less risky, but also promises a far lower return of less than 10% in 12 months.
That's just not enough for me to add the stock to Jubak's Picks, although I think it's a fine
choice for long-term investors looking for solid performance with very little risk.
Qualcomm is riskier than either Sun or Lucent -- but it also promises an upside of about 36%
over the next 12 months. On the downside, Qualcomm has even more Asian exposure than
Sun. Significant portions of the company's chip sales are to Korean manufacturers. The firm
saw strong growth to that market in the quarter just concluded, but my guess is that,
consistent with what other technology companies are reporting, any fall-off in sales is more
likely to show up in the next two quarters. And I can't rule out a general slowing in the
wireless-phone market.
But on the up side, the company has a big new product coming out in February and sales
have hit the sweet spot where profit margins start to rise with volume. It is showing strong
sales to Sprint (FON) in the U.S. and improving volumes at GTE Corp. (GTE), Airtouch (ATI),
Bell Atlantic (BEL) and Ameritech (AIT). Rivals such as Motorola (MOT) and Philips/Lucent have
hit snags in launching competitive CDMA phones, which should be enough to offset pricing
pressure from Samsung.
If you're even more nervous about Asia than I am -- How do you sleep at night? -- you can
postpone any decision on the stock until you hear what the company's management has to
say at its annual meeting with analysts on Feb. 11. I think the upside momentum in the stock
is convincing enough to make the plunge a reasonable gamble now, though. So I'm adding
Qualcomm to the Jubak's Picks Portfolio.
Now we can all see if I've learned anything. |
