Panning for healthy telecom equipment stocks
By Dan Briody
One company that we didn't expect to turn up in our screen was Qualcomm (Nasdaq: QCOM). At 70 times 2001 earnings estimates, the stock actually seems to be a decent value considering that its estimated earnings growth rate is 50 percent.
I think that is around 50 times 2001 estimates.
Caxton
Redherring.com, November 06, 2000
Editor's Note: When we ran a stock screen three weeks ago focusing on attractively valued technology stocks, we asked readers to email us for the complete screen results. We had no idea we'd get such a large response. With that in mind, we've decided to run a new stock screen every other week in the Investor News section. Today, we screened for quality telecommunications equipment companies.
Nortel Networks (NYSE: NT) was gracious enough to give investors a chance to reëvaluate the networking equipment market when it showed signs of slowing two weeks ago. As the dust settled from the massive sell-off that followed, some dark-horse stocks emerged to keep an eye on.
Whenever a sector that's been on as much of a tear as the communications equipment market has shows even the slightest sign of weakening, stocks tank fast. We seized the opportunity to uncover stocks that may have been punished too much and that may be a buying opportunity as a result.
Using a screening process on Baseline, a software program designed to do quick analysis of various stocks, we uncovered 15 communications equipment stocks that still hold a great deal of promise. Some are old favorites, like Cisco Systems (Nasdaq: CSCO) and JDS Uniphase (Nasdaq: JDSU). Some are less trendy, but equally compelling, like Tellabs (Nasdaq: TLAB) and Foundry Networks (Nasdaq: FDRY). And there are more than a few we had never heard of, such as Silicon Labs (Nasdaq: SLAB). We love that ticker symbol though.
METHODOLOGICAL MADNESS
The methodology we used to find these companies was fairly straightforward. We first looked only at companies with market caps greater than $1.5 billion. From there, we set the screen up to find companies that were expected to post earnings growth of at least 30 percent over the next three to five years. In our search for value, we picked companies that were trading at a PEG ratio -- calculated by dividing the 2001 price-to-earnings multiple by the long-term expected growth rate -- of less than 3. By comparison, the PEG ratio for the S & P 500 is 2.2. But most telecom equipment stocks have higher growth rates than the S & P 500, so we were willing to include companies trading at a premium to the market.
Finally, we looked for companies that were trading at least 30 percent off their 52-week highs and that have not seen downward revisions of next year's earnings estimates by analysts in the last three months. All of this information was based on closing stock prices as of November 2.
Needless to say, Nortel and Lucent Technologies (NYSE: LU) did not make the cut. But in Tellabs we think we may have identified a sleeper that has been left behind because of its focus on the less sexy market of digital cross-connects. Tellabs is dominating the market, and demand is expected to remain high through next year as regional Bell operating companies (RBOCs) continue to try to manage ever-increasing traffic over their networks.
Tellabs may be slightly behind in supplying components for the next generation of networks that rely on dense wavelength division multiplexing (DWDM), the area in which Nortel and JDS Uniphase excel. But analysts say Tellabs is bringing those products to market now and is in a good position to succeed. Plus, it has a microscopic PEG ratio of .8. Companies that trade at a PEG below 1 are generally viewed to be incredibly attractive because it means that their P/E ratio is less than their expected growth rate. Tellabs is trading at just 24 times 2001 earnings estimates, even though its estimated growth rate is 30 percent.
"They have several things going for them. Between a high level of customer loyalty among the RBOCs and their reputation for highly reliable products, they are well positioned," says Lawrence Harris, analyst at Josephthal. "And it is trading at a discount, which is unusual these days."
In addition, Foundry Networks caught our eye. The company makes Internet routers for all sorts of service providers and Web hosters and has been doing a pretty good job of it. According to a recent report by Lehman Brothers, Foundry may soon announce that AT & T will start using its NetIron routing platforms. And last month, the company announced that it had quadrupled third-quarter earnings year-over-year and nearly tripled sales, beating analyst expectations by 2 cents per share. But the stock has lost 57 percent of its value this year despite these strong fundamentals. Earnings are expected to grow at a 42 percent clip over the next few years, and the stock is currently trading at about 76 times 2001 earnings estimates, giving it a PEG ratio of 1.8. We think Foundry's due for a pop.
THE BEST OF THE REST
One company that we didn't expect to turn up in our screen was Qualcomm (Nasdaq: QCOM). At 70 times 2001 earnings estimates, the stock actually seems to be a decent value considering that its estimated earnings growth rate is 50 percent.
Rounding out the group were communications chip maker Applied Micro Circuits (Nasdaq: AMCC), which just snuck in with a PEG ratio of 2.8; customer-facing networkers Infonet (NYSE: IN) and Equant NV (NYSE: ENT); wireless local area network (LAN) player Proxim (Nasdaq: PROX); voice and data packet technology company Audiocodes (Nasdaq: AUDC); Tekelec (Nasdaq: TKLC); Inet Technologies (Nasdaq: INTI); UTStarcom (Nasdaq: UTSI); and Turnstone Systems (Nasdaq: TSTN).
Concerns still linger over this entire sector following Nortel's disappointing news, and many uncertainties surround it -- like inventory levels and customer demand for 2001. Some analysts think the market is in a wait-and-see mode until next quarter, which makes a good deal of sense. But a lot of doubts may be allayed on Monday when Cisco reports its fiscal fourth-quarter earnings.
"There is a lot of concern over capital investing and inventory, and these guys have put out high growth numbers, so people are waiting before they dive in," says Joseph Wolf, analyst at UBS Warburg Dillon Read. "These are not bargain-basement prices, but I suppose if you timed it well, you could make a lot of money. But I don't think most people are that savvy."
Whether the market has truly begun a slowdown or not, there is still some substantial growth in the years ahead. We picked out a few sleepers that we feel could be poised for a good year ahead, but it is of course possible that the slowdown is rea, and that these stocks have further to fall. Either way, if you want to get into communications equipment, these 15 stocks are the relative bargains.
Discuss stock market trends in our Market Watch forum, or check out forums, video, and events at the Discussions home page. |
