Jan, on SUNW Hardware for a Tech-Portfolio Fixit
By Mitch Ratcliffe
12/15/2000 10:18 AM EST
The latest market stumble has provided more evidence that tech investors can -- and should -- sit comfortably on the sidelines for the rest of the year. So sit tight and keep your eyes peeled for buys for the Tech Rebuilding Portfolio while you sip your eggnog. (Click here, here and here to read previous Tech Rebuilding Portfolio suggestions)
In recent weeks, personal computer stocks have been hard-hit by earnings warnings. Compaq (CPQ), Gateway (GTW), Hewlett-Packard (HWP) and Apple (AAPL) have revealed serious problems with demands for their desktop products. Intel (INTC), another holding in my Tech Rebuilding Portfolio, also announced a shortfall in the current quarter, but investors have reacted positively to Intel's slowing growth, presumably because this was already priced into the stock.
The question is, as we look forward to 2001, which of the computer-hardware companies should investors be adding to recoup gains lost during 2000?
Focus on the Servers
When you think of computing hardware, you should focus on the servers connecting the Internet, not just the computers sitting on people's desks. The clear leaders in this space are International Business Machines (IBM) and Sun Microsystems (SUNW).
According to research firm International Data Corp., server market revenue in the latest quarter grew by 12% year over year. Like the PC before it, though, servers are under price pressure -- shipments had to grow by 21% to keep revenue growth up by 12%. This indicates that many more companies are buying into the Internet and corporate networks as a foundation for their businesses.
IBM, trading Thursday at 92, is off its 52-week highs by 32%, demonstrating far more resilience in this bear market than many of its counterparts. By contrast, Sun is down 50% since Sept. 1, when it peaked on news that it would split two-for-one in the first week of December.
Big Blue's stock is priced for bargain-hunters, as well, at 22 times trailing 12-month earnings and 18.25 times projected 2001 earnings. The company, which is broadly diversified in computer hardware, chip manufacturing, consulting and other areas, is almost dead-on industry averages for operating margin and earnings growth -- because it combines this very average performance with leadership in several key sectors, including servers, it produces excellent and predictable returns. No wonder it has been a blue-chip stock for two generations.
Let the Sun Shine In
Sun is the other buy in this space because it has established a clear leadership position in the UNIX space, dominating server and workstation sales with very high margins. Where Big Blue is totally average, Sun's operating margin is twice the industry average and it is growing roughly three times faster than competitors.
According to an IDC study released this week, Sun has passed both Compaq and Hewlett-Packard in the server market during the past quarter, leaving only IBM ahead.
Trading at 32 during Thursday's session, Sun is still priced aggressively, at 51 times trailing earnings. But it is currently trading at 36 times expected 2002 earnings -- and analysts have been raising estimates in recent weeks.
I would add both these stocks to my Tech Rebuilding Portfolio. IBM is currently a good buy, but I would look to acquire shares below 90 to accumulate 5% of tech holdings. Likewise, Sun has room to move to the downside, possibly below 27 in coming weeks, when I would snap up shares to account for 5 percent of one's tech portfolio.
Bargain in the Dell
Of course, you should still keep your eyes trained on the PC market (with IBM you get a two-fer, because it also is a leading seller of desktop PCs -- number five in the US and number four worldwide, according to IDC). But in addition to IBM, consider buying Dell (DELL).
The Texas-based PC manufacturer has shed two-thirds of its value during 2000. Dell reached a 52 week low on Dec. 7, closing at 17 1/4.
Friday may see additional downward pressure in the wake of Microsoft's (MSFT) earnings warning. Dell was trading at 19 1/8 after-hours when it had closed at 19 15/16 during the trading session.
The continuing uncertainty about PC sales is ample reason to hold off on Dell stock today. A raft of insider sales between $35 and $38 during the past quarter also indicates that management believes it will be a while before the company sees those prices again, so follow their lead and relax until the price is right.
As the bears retreat, Dell is a buy, because it is the US PC sales leader with 19.7% of the market, according to IDC. Compaq, number two in the US with 17.3% of the market, is the worldwide leader, edging Dell's 11.6% market share with a total of 14%.
Compaq Diss
Dell's just-in-time inventory and manufacturing systems provide it an unparalleled ability to respond to the customer's desire and the changing costs within the PC market. Compaq turns its inventory just 14.5 times a year while Dell does so 57.50 times. Too, Dell's Web-based ordering system is a natural destination for a PC buyer, simply to compare prices before going to a computer store.
Consider that Dell has a lower gross margin than Compaq, which has to support higher customer-acquisition costs, as well as higher inventory costs. But, when all is said and done, Dell ends up with an operating margin 37% higher than Compaq.
Both Dell and Compaq were candidates for the Tech Rebuilding Portfolio, but Dell's processes and management is so clearly superior that it gets the nod. I'd add Dell to account for 5% of technology holdings at or below $18; at higher prices, I'd sit tight.
Ratcliffe is Chief Content Officer and and Editor-in-Chief of the ON24 Network, a personalized financial broadcast network for individual investors. He is also a longtime executive and investor in the technology industry. Ratcliffe's insights and analysis of the high-tech industry will appear twice each week. He does not hold a position in any of the companies mentioned. |
