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<<Jubak's Journal //MSFT Investor // 2/01/00
Dell? Yes. Compaq? No. Qualcomm? Maybe.
In a tale of three earnings reports, Wall Street's analysts give you their informed opinions. Here's how you might decide for yourself if you should heed the warnings.
By Jim Jubak
If Wall Street ran the Olympic high jump, the bar would be set four feet off the ground and everybody would go home with a medal.
Remember this love for the low bar -- one that everybody is sure to clear. It explains why analysts love certain kinds of disappointments and not others. For example, it will tell you why Dell Computer (DELL) is now, according to Wall Street, a buy, why Compaq Computer (CPQ) isn't and why Qualcomm (QCOM) is a maybe. And it will help you figure out whether you agree with that assessment.Jubak's Journal Community
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Let's start with the individual stocks.
After the market closed Jan. 26, Dell Computer warned that earnings for the quarter ending in January would be a nickel a share below analyst projections. Revenue would grow by less than expected, too. The days of 50% growth are over, management warned, and investors should get used to 30% growth in the future. The next day, analysts rushed to upgrade the stock. Four major firms, in fact, slapped new "buy" ratings on Dell. With that kind of support, the stock stumbled instead of tumbling. Shares finished the week on Jan. 28 down just $3.13, or about 8%.
A day before Dell's warning, Qualcomm embellished its quarterly report with a warning of its own. The company reported earnings of 25 cents a share -- a penny above the analyst consensus, but 2 cents below the last-minute, informal "whisper number" circulating on Wall Street. Looking ahead, it said shipments of chips and wireless phones in the current quarter could fall from the levels of the previous three months. No Wall Street cavalry to the rescue this time -- even though the company said it was comfortable that it could meet the consensus earnings estimate for the year. Merrill Lynch and Salomon Smith Barney both downgraded the stock. Shares of Qualcomm fell $24.88 the next day, and then kept on tumbling Thursday and Friday. The final damage came to $37.38 in three days, a 25% drop.
Finally, also on Jan. 26, Compaq reported earnings of 16 cents a share (before one-time investment gains), a penny above analyst expectations. It's true that was down from the 43 cents the company earned in the same quarter of 1998, but it was up sequentially from the 8 cents the company earned during the previous quarter. Revenue followed the same pattern -- up 11% from the previous quarter but down 4% from the year-earlier period. In a later meeting with analysts, CEO Michael Capellas said he was comfortable with Wall Street projections that Compaq would earn $1.06 a share in 2000. Revenue easily should grow at 10% to 12% this year, double the 5% revenue growth achieved in 1999, Capellas said. And 15% revenue growth certainly was possible. What did all that good news earn Compaq's stock? Two upgrades and, over the next few days, a 16% decline for a stock seemingly bathed in good news -- about twice the drop that Dell recorded after issuing its bad news.
Expensive, but not out of line
Why did Dell Computer get off so easily in comparison to Qualcomm and Compaq? Because Dell lowered the bar for success going forward, exactly as analysts had hoped the company would do.
The market already had decided that Dell wasn't a 50% growth company anymore. A year ago, Dell traded at a trailing 12-month price-to-earnings ratio of 115. Expensive, but not completely out of line for a company that had grown revenue by 48% from fiscal 1998 to fiscal 1999 and that had increased earnings per share by 64% in the same period. But after a series of rocky quarters and an earnings warning late in 1999, the stock has gradually moved lower, so that right now it trades at a price-to-earnings ratio of 61. In this market, that's not out of line for a company growing by 30% a year.
Consensus EPS Trend
Until last week, however, Dell management hadn't made this transition, continuing to say stubbornly that it would keep growing at 50% a year. Analysts concluded that refusing to lower the growth bar amounted to a guarantee that the company would report one disappointing quarter after another. The stock might climb from $40 to $53, as it did in the last quarter of 1999, but that appreciation wouldn't last. The stock was likely to get knocked down again each quarter when it failed to meet the company's own overly ambitious goals.
Following the Lucent Technologies (LU) debacle, Wall Street is very leery of companies that stubbornly seem to be setting the bar too high. (Lucent's stock blew up early this January, falling 28% in one day, when the company finally admitted that it wouldn't be able to meet the ambitious goals for growth it had set for itself in 1999.)
That, I think, explains the negative response to Qualcomm's warning. In its announcement, it clearly said that sales of chips and phones could be lower next quarter than they were this quarter. And yet management remained comfortable that it would earn more per share than in the current period. See why Wall Street might be uncomfortable with that reasoning? Was this a company so well-managed that it could produce higher earnings on lower sales? Or did management simply not want to face up to the possibility that the company might break its string of reporting sequentially higher earnings every quarter?
Analysts using discretion
There is a good chance that Qualcomm is setting itself up for another warning next quarter, and after being blindsided by that big drop in the price of its shares, analysts saw discretion as the better part of valor. That's understandable when the stock trades at a P/E ratio (267) high enough to magnify the smallest earnings disappointment. If guidance from the company was convincing later in the quarter, they could always boost their estimates. In the meantime, the company had kept the bar too high and backing off a tad seemed wise. Of course, that decision increased the size of the drop in share price.
I think the reaction to Compaq's earnings announcement is even more telling. Whereas Wall Street analysts decided to hedge their bets with Qualcomm, they delivered a rather stark message to Compaq: "We don't believe you."
Think about it. Here's a company with a great name, an amazing customer list and solid technology badly in need of a turnaround. And what does management deliver? The first signs of exactly that change in fortune. Instead of declining from the previous quarter, revenue and earnings both rose. A lot of work remains to be done, but Compaq's management painted a picture of continued progress for 2000. Revenue this year will grow by 10% to 12%, and could even reach 15% -- triple the anemic 5% revenue growth Compaq delivered in 1999.
So why didn't the stock soar? Stocks are supposed to trade on expectations, right?
Because analysts focused on all the problems that haven't been fixed yet, and on the possibility that they couldn't be fixed -- at least not by current management. In the days after Compaq reported, I read analyst reports that focused on the continuing problem posed by the company's two-tier distribution system -- the company's mix of 30% direct and 70% retail just can't compete on costs with Dell's 100% direct model. The enterprise and services business that Compaq so expensively acquired when it bought Digital Equipment saw a 3% drop in sales in the quarter. And Compaq continues to lose share in the server market to Sun Microsystems (SUNW) and Dell.
The company had set the bar for 2000 at 10% to 12% growth -- and even hinted at 15% -- and, given the dimensions of the company's problems, Wall Street decided that was just too high.
Now it's up to you to decide
Wall Street isn't necessarily right about all this, of course. Dell could miss even that 30% growth rate. Or if it delivers that number, a significant group of investors who remember the old, 50% Dell might dump shares. After selling some of its worst-performing units, Qualcomm indeed might be able to raise margins so that it can make more money on lower or flat sales. And Compaq's management could be on its way to continuing the turnaround.
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In their reactions to these warnings and reports, Wall Street's analysts have given you their informed opinions. Now it's up to you to decide for yourself whether Wall Street is right. After doing my own research, I happen to agree with the Wall Street story that I've outlined above in two of the three cases. That's why Dell is staying on Jubak's Picks and why Compaq isn't joining that portfolio.
I'm not as convinced on Qualcomm. At current levels around $110, the stock is still a little more expensive than I'd like. But it is certainly getting interesting.
It's clearly worth watching here. By discounting the outlook offered by Qualcomm's management, Wall Street analysts have helped to lower the bar for the company and the stock. A body of investors will be amazed if the company manages to hit the consensus estimate next quarter, let alone beat some higher whisper number.
I'm not sure that's taken all the overblown hopes out of Qualcomm. Plenty of investors still expect too much from this stock. But analyst reaction, if not management guidance, has lowered the bar. And that makes it an opportunity worth investigating, because nothing pays off better in the market than a stock that jumps a bar that no one had expected it to clear in the first place.>>
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BTW: At this time I do not own any of the stocks mentioned above. I follow DELL and QCOM for some relatives who are still invested in them.
Best Regards,
Scott |
