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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Dave who wrote (14679)	6/23/2002 9:07:00 AM
From: Dale Baker	Read Replies (1) \| Respond to of 78758

All's well that ends well, my friend. ;<) Now for a word about stocks that definitely ARE NOT value plays: Bottom Fishing in Techs 20-Jun-02 00:08 ET [BRIEFING.COM - Robert J. Reid] So you want to go bottom fishing in technology. You say to yourself: look how cheap these names are. If XYZ Corp is trading at $4, it would need to go only to $8 for a double and $12 for a triple. That may be true, but many of these names can go even lower when you consider their still expensive valuations. Busting the Myth Growth companies rightfully command higher multiples than cyclicals. If you were to normalize (smooth out for recessions and recoveries) growth rates for cyclicals, the line would be fairly flat. That does not deserve much of a premium. Myth: Techs are pure growth companies and they are going to change the world and they are just down right now and they're on their way back and just wait until the Nasdaq comes roaring back. And, and, and.... . Reality: These are not pure growth companies. There may be no such thing. Even the purest growth companies have a degree of cyclicality to them. Stop pricing them as if they are pure growth. You could make a good argument that most tech names are more cyclical than growth. New Paradigm The degree of cyclicality in the tech world varies by industry. It's clear semiconductors go through cycles as economic cycles fluctuate. Optical stocks are probably less clear as as they lack the history of semis, for example. Also, there have been so many startups popping up over the last few years that it is more difficult to say for sure. Software companies have a degree of cyclicality as enterprise IT spending ebbs and flows. Listen in on any enterprise software conference call and this becomes clear. These same calls 2-3 years ago made it sound like IT spending would be robust for the next decade, but they have slowed as the economy has slowed. The purpose here is not to rank which tech sectors are more cyclical than others. Nor is it to argue that they deserve the same multiples as true cyclicals like General Motors, Deere, Burlington Northern, Exxon Mobil, UAL Corp. The goal is to encourage readers to challenge the way they think about many tech stocks. Many tech stocks still have high valuations. We argue that some cyclicality needs to be priced in. Granted, optical stocks are not railroad companies, but they are not so different as to justify the huge disparities in valuations. Here are some examples of the growth / cyclical disparity: Technology Company Ticker Stock Price Market Cap (bln) 2002E Sales (mln) Price/Sales 2002E EPS Price/Earnings Year Ending JDS Uniphase JDSU 2.77 $4.2 $943 4.5x (0.07) N/A June 03 Sun Micro SUNW 6.03 $19.6 $14,754 1.3x 0.18 33.5x June 03 Yahoo YHOO 16.02 $9.6 $898 10.7x 0.10 100+x Dec 02 True Cyclicals Company Ticker Stock Price Market Cap (bln) 2002E Sales (bln) Price/Sales 2002E EPS Price/Earnings Year Ending General Motors GM 56.34 $31.6 $167 0.2x 5.83 9.7x Dec 02 Norfolk Southern NSC 22.11 $8.6 $6.3 1.4x 1.17 18.9x Dec 02 Wausau-Mosinee Paper WMO 11.60 $0.6 $0.9 0.7x 0.45 25.8x Dec 02 One More Thing Be nervous about warning season, look at AMD. A rational person could have concluded that all of the bad news had been factored into this chipmaker First, Intel recently issued a fairly sizable warning. With AMD being its largest competitor in the PC space, it did not take a brain surgeon to connect the dots that AMD may be seeing similar conditions. As expected, the stock traded lower back then. OK, bad news priced in. Second, the valuation on AMD has been pretty beaten down. It has $1.3 bln in cash/inv, or $3.72 per share. (Granted, its debt-to-equity ratio is up to 24% from 16% at year-end, but still pretty cheap.) While the forward p/e was still high at a 20x, it was trading at about 1x sales and 1x book value.You would think that much of the bad news was priced in. So what happens? AMD warns and the stock still gets hammered 16% even with Intel, even with the valuation, even with the overall market in a slump. Our point here is that maybe not all of the bad news is priced into techs and they can trade to head-scratching levels. It was a similar story with Apple (AAPL 17.12) which traded down 15% after a warning. Conclusion It's tempting to go for these beaten down names, but do not be surprised to see them go lower. Yes, they have more growth characteristics than the obvious cyclicals. However, ask yourself is it that much better? Is Cisco ever getting back to 40% growth? Probably not. But investors are paying 5x forward sales and a forward p/e of 28x to find out. EMC trades under $7, but it still has a market cap of $15 bln and a price/sales ratio close to 3x. Sure, it'll post decent growth again, but just be sure you're comfortable paying these multiples when you compare them to true cyclicals. Our point here is not to be all out bearish on tech. There are likely some names that will post great returns over the next year or so. We just want readers to be cognizant of valuations and factor them into the buying decisions. Comments may be emailed to the author, Robert J. Reid, at rreid@briefing.com