Are investors pricing in a no-growth future?
Columnist Arnie Berman writes that while stocks may be expensive, they're as cheap as they've been in a decade when analyzed on the basis of their earnings potential.
By Arnie Berman
The Red Herring
May 1, 2002
If you're one of the many who's recently been told that technology stocks are "still expensive" despite the share price declines of the last two years, you should investigate whether that assessment is merely the result of dividing unusually depressed stock prices by unusually depressed earnings. If it is, you've got something else to consider, because it has become quite clear that technology spending is cyclical. And history has shown that the right time to invest in cyclical industries is at the end of a downturn, when reported earnings are most depressed and earnings multiples appear sky high.
Cyclical industries should never be valued on the basis of their trough earnings. At cyclical bottoms, earnings multiples tend to look ridiculous. Instead, investors should consider potential. And the most concrete way to measure earnings potential is to use the four consecutive quarters with the highest total earnings per share. Of course, acceptable multiples on peak earnings must be lower than those calculated by other methods, and should vary with growth prospects and expected time to recovery. But the approach is as useful in assessing technology stocks as it is for traditional industries, like paper and chemicals.
Some portfolio managers rightly argue that it's a fool's errand to employ idealized earnings that might be difficult to obtain again. The approach could very well be misleading for companies that served as barometers of excitement about Web project spending--like Cisco Systems, Oracle, Sun Microsystems, and EMC (Nasdaq: CSCO, ORCL, SUNW; NYSE: EMC). For the majority of highly capitalized issues in the sector, though, it's a different story. These days, the best capitalized companies are once again those with the greatest revenue bases, the highest profits, and enough history to have endured multiple cycles. For those companies, peak earnings results do not represent a summit more remote than Mount Everest, but a level that likely can be achieved again in 2004 or 2005.
Consider a basket of end-market technology manufacturers, or every company that uses silicon in the production of its wares--PCs, servers, storage gear, wireless handsets, and communications equipment. Which of these end markets have investors been excited about lately? None of them. The absolute multiples on these stocks, based on their prior peak earnings, have almost never been lower. Even relative to the S&P 500, the stocks look much cheaper than in 1992. Does this reflect a belief in a low-growth future for technology goods? Yes. Is that belief grounded in the prevalent concern that there is no new "killer app" to drive demand? Yes again.
But the search for the next killer app is misdirected. The last killer app was not a spreadsheet or a word-processing program. It was the killer platform--the ability to be productive every time you sat down at a desk, without the help of secretaries, number crunchers, or an art department. The next killer platform will be the ability to receive, transmit, and manipulate information--anytime, anywhere, and really fast.
Broadband and wireless spending may not be huge over the next six months, but the long-term prospects remain enormous. The challenges created by the marriage of voice, video, and data are no less daunting than the prospect of tying together the pipes for corporate computing, cable television, and traditional phone networks. The integration will make most of today's communications infrastructure obsolete.
Investors bemoaned the lack of a new killer app just as often in 1985 and 1991. In both of those periods, technology profits were under pressure in a period of difficult architectural transition. But both were great years to make long-term investments in well-positioned companies. Today, investors in companies like Cisco, Ciena, JDS Uniphase, Microsoft, EMC, Nokia, Sprint PCS, Taiwan Semiconductor Manufacturing, Texas Instruments, and United Microelectronics will likewise be rewarded (Nasdaq: CIEN, JDSU, MSFT; NYSE: NOK, PCS, TSM, TXN, UMC).
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Arnie Berman is a managing director and technology strategist at the SoundView Technology Group and is chairman of the firm's stock selection committee. |
