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Telecom Equipment Shares Lead; Are They Worth It?: John Dorfman
Telecom Equipment Shares Lead; Are They Worth It?: John Dorfman
(John Dorfman is president of Dorfman Investments in Boston.
His opinions don't reflect those of Bloomberg News. His firm or
its clients may own or trade investments discussed in this
column.)
Boston, Dec. 9 (Bloomberg) -- With three weeks left in the
fourth quarter, telecommunications equipment stocks are
overwhelmingly the best performers.
The telecom equipment stocks have rung up a 45 percent gain
from Sept. 30 through yesterday. Among the 89 industry groups in
the Standard & Poor's 500 Index, no other group is above 33
percent; the median gain is 3 percent. But I suspect the telecom
stocks' performance is unsustainable and will slow down or
reverse in the first quarter.
The leader in the telecom equipment group this year is
Qualcomm Inc., which began the year at about $26 a share and is
now trading near $400. It is up 109 percent this quarter alone,
through yesterday.
Based in San Diego, Qualcomm is a leading maker of cellular
phone equipment and related chips and software. It also licenses
its code division multiple access (CDMA) technology to various
phone companies.
Network Appliance Inc. has been even hotter than Qualcomm in
the fourth quarter, up 120 percent. Nortel Networks Corp. is up
66 percent. Of the 13 stocks in the telecommunications equipment
group, 11 are up 50 percent or more this quarter.
Phone Proliferation
Of course, investors are right to perceive
telecommunications as a growth area. Just look in your own house.
A few years ago, you may have had only one phone. Today, you
might have two phones, plus a line for a computer modem and maybe
a fourth line for a home-office fax.
The same proliferation of lines has occurred in offices.
Phone lines that once carried mostly voice traffic now crackle
with voice, fax, and data transmissions. And the burgeoning
Internet requires a huge amount of telecommunications equipment
to make sure that e-mail and chat messages get where they're
going.
The question is how much should you pay up for growth?
History shows that it's a mistake to pay too much, even when
prospects look excellent. Human beings have a hideous record in
foretelling the future. When we try to do so, we tend to
extrapolate the recent past.
A Dangerous Game
The recent past has been rosy for these companies. Qualcomm,
for example, earned 91 cents a share in the quarter that ended
Sept. 30. That compares with 27 cents in the year earlier
quarter, and 6 cents in the same quarter three years ago. But
extrapolation is a dangerous game to play: Parabolic rises in
either earnings or stock prices are usually the sign of an end
game, not an opening. Qualcomm appears overextended to me.
The stock sells for 98 times estimated earnings for the
fiscal year ending next September. Network Appliance sells for
201 times estimated earnings for its fiscal year ending next
April. Nortel Networks sells for 84 times estimated 1999
earnings. I think it's imprudent to pay such multiples.
Qualcom shares, and those of other telecommunications
companies, have probably benefited a little bit from window
dressing, as portfolio managers want to be ''seen'' holding a
year's leading stocks at yearend. This is, of course, a silly
custom, since discerning clients will wonder why, if the manager
holds such great stocks, the overall performance wasn't better.
But the practice goes on, nevertheless.
Come the first quarter, window dressing will probably give
way to tax-inspired selling. People who have multiplied their
money by a factor of 14 in Qualcomm during 1999 may want to lock
in some gains. By waiting until January to sell, they pay the
capital-gains tax in April 2001 instead of April 2000.
A Different Story
These arguments aside, how do I know that the leadership of
Qualcom and the telecommunications stocks is temporary? Because
everything in the stock market is temporary. If something can't
go on forever, it will stop.
It's a much different story with the second-leading group in
the quarter, the hospital management stocks. These have risen 33
percent for the quarter, but that is a bounce back from depressed
levels. They are still below where they were two years ago. (By
contrast, telecommunications equipment stocks have quadrupled in
two years.)
I'm not objective about the hospital management stocks,
since the two that constitute the S&P 500 industry group --
Columbia/HCA Healthcare Corp. and Tenet Healthcare Corp. -- are
held by Dreman Value Management. My friend and mentor, David
Dreman, runs that firm, and I have a continuing affiliation with
it.
Big Losers
Be that as it may, I think the hospital management stocks
are a better bet over the coming 12 months than the telecom
equipment stocks. You can buy a dollar's worth of Tenet
Healthcare earnings for $15. In other words, the price/earnings
ratio on Tenet stock is 15, based on the past four quarters'
earnings. On the same basis, it costs you $165 to buy a dollar's
worth of Qualcomm earnings.
So much for this quarter's winners. Let's look briefly at
the big losers in the S&P 500 this quarter. The worst performer
among the 500 stocks is McDermott International Inc., a New
Orleans-based company that makes Babcock & Wilcox steam
generating equipment, builds offshore oil-drilling platforms, and
and supplies fuel and reactor parts for nuclear submarines (among
other activities).
McDermott International stock is down 60 percent this
quarter through yesterday, to $8.13 from $20.25. Ikon Office
Solutions Inc. is down 46 percent, J.C. Penney Co. is down 45
percent, Baker Hughes Inc. is down 42 percent and Raytheon Co. is
down 42 percent.
It won't surprise regular readers of this column to hear
that Raytheon is one of my favorite stocks. I think the defense
stocks are overdue for a good year and will get one in 2000. U.S.
government spending on defense procurement rose last fiscal year
for the first time in 14 years.
The quarter's biggest loser, McDermott International,
doesn't look bad to me either. The stock has been extremely weak
because the company said it may have to pay more than expected to
settle asbestos-related legal claims, and because demand for oil-
drilling platforms has been slack.
Most analysts, spooked, rate McDermott ''hold,'' which is
frequently a euphemism for ''sell.'' Some of these same analysts,
however, liked the stock at twice the price. I like it at the
present price, which is 9 times estimated earnings for the fiscal
year ending in March, 0.6 times book value (corporate net worth
per share) and 0.2 times revenue. |
