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Strategies & Market Trends : Z Best Place to Talk Stocks -- Ignore unavailable to you. Want to Upgrade?

To: Larry S. who wrote (34025)	10/27/2001 6:03:18 PM
From: E.J. Neitz Jr	Read Replies (1) \| Respond to of 53068

Oct-26-2001-Merrill Tech Comments: TechStrategy Steven Milunovich, Technical Strategist Tech-sector profit margins are low and going lower. That’s the message that comes from a study we recently conducted of profit patterns among 90 large tech companies during the past 20 years. It fits with our latest survey of chief information officers; more than 90% of those who responded said that pricing pressures on vendors will worsen next year. Our work shows that tech-sector profit margins are at a 20-year low. That indicates that it may be too optimistic to use 1996 or 1998 trough levels for valuation purposes, particularly for price-to-sales ratios (sale are worth less than they were then in terms of profits and cash flows). We think that it may be appropriate to look back to 1990 valuation levels. Although it is tempting to adopt the reversion-to-the-mean argument and to look ahead to the benefits associated with cost reductions, we think that investors should be prepared for profit margins to decline further before they begin to improve. Revenue growth tends to lead operating margins by one-to-two quarters coming off a bottom. Our analysts expect year-to- year sales to decline for several more quarters. From a second-derivative standpoint, sales growth should bottom in the fourth quarter of this year; even so, actual sales increases aren’t likely until the third quarter of 2002. That points to more pressure on margins during the next few quarters. Looking at groups, the profit margins of some have broken down to new lows, and those of others haven’t. In addition, recovery prospects differ from group to group. In general, margins for groups with more “history,” such as hardware and semiconductors, have not broken their historic lows, while margins for newer groups, including software and communications equipment, have entered uncharted territory. Analysts who follow semiconductor and software companies generally forecast a trough in the fourth quarter and a V-shaped recovery. If that view proves to be correct, investors should stay away from expensive issues in those areas until a recovery is in sight, then buy. Meanwhile, the communications equipment area generally is considered to be an early-cycle group. This time around, however, it makes sense to think that the area won’t be so quick to bounce back because the outlook for spending by service providers is weak into 2003. Our review of tech profit margins reinforces our long-standing view of the prospects for the tech sector as a whole: the workout period is going to be longer rather than shorter, and the best we can say is that the stocks will bump along the bottom in the months ahead. We think that investors should equal-weight the sector, at best, and sell into nearby rallies. The tech bear still is growling, in our judgment.