Risk alert: Tech stocks
31 Mar 2004
General prospects look better, but some individual situations are mind-boggling.
Marc Gerstein
Director of investment research
Reuters.com
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The bad news for tech is that March has been a rough month. The good news is that tech, as reflected in the NASQ 100, hasn't had a noticeably tougher time than the S&P 500. Looking ahead, we're not out of the woods. IT spending seems likely to recover, but valuations are high and we cannot assume every company will benefit equally from cyclically positive developments. And geopolitical concerns have recently come back to the fore. On the whole, it's OK to stay with tech (the cyclical upturn will, likely, unfold). But be attentive to individual names and make sure each one you hold is supported by a legitimate stock-specific investment case.
Continued below
Table 1 below lists high-risk-alert tech stocks with market capitalizations of at least $500 million.
Table 1
Tech stocks with High risk alerts
Company Industry
Actel Corporation (ACTL.O) Semiconductors
Ariba, Inc. (ARBA.O) Computer Services
Celestica Inc. (CLS.N) Electronic Instr. & Controls
International Business Machines Corp. (IBM.N) Computer Hardware
Integrated Circuit System (ICST.O) Semiconductors
Lattice Semiconductor (LSCC.O) Semiconductors
Manhattan Associates, Inc. (MANH.O) Software & Programming
Micrel, Incorporated (MCRL.O) Semiconductors
Nortel Networks Corporation (NT.N) Communications Equipment
Open Text Corporation (OTEX.O) Software & Programming
Solectron Corporation (SLR.N) Electronic Instr. & Controls
Note: Table is based on data as of 3/26/04. Because risk-alerts are updated after every trading day, it is possible that when you check risk-alert details for individual stocks, you may occassionally see different scores.
Here are some noteworthy situations from the High risk alert group.
International Business Machines (IBM.N): On paper, it's hard not to like IBM. Even in this day and age, it remains one of the biggest and most recognizable technology companies, and with a sustained upswing in IT spending increasingly likely, that should be a good thing for investors. Moreover, its service-focused business strategy seems to nicely align the company with where the business world is going, to wit, an increasing number of companies recognizing that IT is not their main endeavor and, hence, choosing to outsource more and more. The negatives come when I expand my view to include other companies, and re-phrase the question away from "Why not IBM?" to instead ask "Why IBM?" Others, such as Hewlett-Packard (HPQ.N) are also in the services game. Can IBM beat its rivals? Who knows? It certainly did not do that in hardware to the extent anticipated by previous generations of IBM bulls. And from a data perspective, IBM is not exactly overloaded with above-industry showings, something stressed heavily in ReutersSelect screens, none of which include IBM as of this writing. If you want to lean against the High risk alert score, so be it. But just make sure your reasons are more substantial than the old refrain "You can't go wrong with IBM." Frankly, nothing more than that is jumping up at me right now.
Open Text (OTEX.O): This looks like a truly terrific company. It produces software to help large organizations better manage documents and workflows and collaborate from various locations. Business is strong, and the company is growing externally, having just purchased a German document management outfit. And unlike IBM above, in addition to having a High risk alert score, OTEX also appears in one of our ReutersSelect screens, the one based on High P/E Ratios. That, as it turns out, is the main issue to consider if one is deciding whether or not to continue to hold the stock. The High P/E Ratios screen seeks firms that are richly valued but also show some evidence of deservingness. In the case of OTEX, near-term trends are, indeed, good. As to the longer term, I estimate that it would take a five-year EPS growth rate of about 20 percent to justify the current stock price. That, in fact, is the consensus analyst expectation. However, it is based on the work of only six analysts, compared to 27 who are publishing estimates for the 6/05 fiscal year. And speaking of 6/05 estimates, the consensus calls for an increase of about 45 percent over the fiscal 6/04 consensus. So on the whole, although I like this company a lot, I am a bit leery of Wall Street's handle on the situation. It seems that analysts are being very quick to use current strength as a springboard for expecting great things in '05, with too many not bothering to look beyond that. That presents a big risk of short-term disappointments, which is further aggravated by the fact that OTEX now has to integrate its newest acquisition, a process that always entails pothole risks.
Nortel Networks (NT.N): As with IBM, on paper, NT looks like a must-own stock. It's a major league player in telecomm networking equipment; a stature reinforced recently by an important new-generation wireless contract win with Verizon (VZ.N). As to cyclical issues, we're currently still at a pretty low point, which has, historically, been the time to buy and hold such stocks. But NT isn't just any old cyclical. It's a former bubble-era superstar that has traditionally attracted a level of attention out of proportion to objective performance. And the present situation may fall within that mold. I estimate that if the stock can fetch an 80 percent premium to the S&P 500 five years hence (a probably-aggressive assumption), it would require annual EPS growth of about 10 percent to justify today's quote. At first glance, that sounds like an easy target. After all, NT is a company that can toss around popular buzz phrases like "3G wireless." Interestingly, though, the consensus long-term analyst EPS growth projection is only 10 percent, and that's in a range of 5 to 15 percent. Note, too, that only nine analysts out of 37 who are publishing '04 estimates, are taking the trouble to think about the long term. This worry (do they have a handle on the situation?) resembles OTEX. But if you're going to own a stock like this, at least OTEX has a solid track record of making money. NT does not. And to top it off, the SEC is looking into NT's recent results, adding a layer of uncertainty.
Celestica (CLS.N): This is another stock that ought to be a great to own. But once again, there may be a gap between "ought to be" and "is." The company is a contract electronics manufacturer. In other words, it does the manufacturing for other electronics outfits that want to save money by outsourcing. As noted above, outsourcing is likely to emerge as a major business trend, and tech spending as a whole is likely to enjoy a good cyclical upswing. But even in the best of times, not all companies in a group prosper equally. And right now, there are questions with CLS. Its CEO retired and a search is on for a replacement. And it has been losing market share to rivals Flextronics (FLEX.O)and Jabil Circuit (JBL.N). And as with NT, too many analysts are sticking their head in the sand when it comes to the long-term growth issue. Only 14 out of 34 analysts are publishing projections, and among these, the range of expectations, eight percent to 33 percent, is ridiculously wide.
Besides the above stocks, you may also want to review your rationale for owning any of the stocks in Table 2. These are tech stocks with market caps of at least $500 million that have Medium risk alert scores, but which to me seem more significant than Mediums in general because of the specific signals that are triggered. Medium scores are assigned to stocks that meet three or four out of six risk alert tests (High scores are given to stocks that trigger five or six). Among the three- to four-signals flashed by the stocks in Table 2 are those involving rising short interest and analyst rating downgrades. In other words, it's not something like a stock drifting because it needs a breather. It's a direct statement of thumbs down based from key market constituencies.
Table 2
Noteworthy tech Medium risk alert situations
Company Industry
Borland Software Corp. (BORL.O) Software & Programming
Cypress Semiconductor Corporation (CV.N) Semiconductors
Eclipsys Corporation (ECLP.O) Software & Programming
ESS Technology, Inc. (ESST.O) Semiconductors
Juniper Networks, Inc. (JNPR.O) Communications Equipment
Moog Inc. (MOGa.N) Scientific & Technical Instr.
NCR Corporation (NCR.N) Computer Services
Siliconware Precision Industries (ADR) (SPIL.O) Semiconductors
Thermo Electron Corporation (TMO.N) Scientific & Technical Instr.
Note: Table is based on data as of 3/26/04. Becasue risk-alerts are updated after every trading day, it is possible that when you check risk-alert details for individual stocks, you may occassionally see different scores.
As is generally the case when dealing with risk alerts, these aren't necessarily Sell signals. But they are cues that should prompt you to at least refresh your analysis of these stocks should you own them.
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Using risk-alerts to decide to sell or hold
The decision to sell or hold doesn't have to be as difficult as many say it is. Ultimately, all you really need to do is put yourself in the place of the person who might buy any shares you choose to sell.
If you conclude that this theoretical buyer will be excited about the great opportunity he or she is being offered, it may be a sign you shouldn't rush to kick the stock out of your portfolio. If, on the other hand, you believe your imaginary trading partner will be unimpressed, perhaps it would be wise for you to get rid of that stock before too many real trading partners start reacting the same way.
The hardest part of all this is time management. You can't review every stock every day. To help alert you to the need to review stocks you already own, we offer six "Risk Alert" screens. We also provide you with an Excel spreadsheet (which includes the results of our risk-alert screens) to help you match the screens against the stocks you own, and customize the system by assigning different priority scores to each risk alert.
Here are the six risk-alert screens:
Estimate Revisions: During the past week, there was a downward revision in the EPS estimate for the company's current fiscal year
Analyst Recommendation: Overall analyst ratings have become more bearish in the past four weeks
Institutional Selling: During the most recently reported period, institutions have been net sellers of the company's shares
Shorted Shares: The Short Interest Ratio is above 3 percent and has grown in the past month
Price Deterioration: The stock underperformed the industry average by at least 35 percent during the past four weeks
Price Momentum: The stock's relative (company to industry) four-week share-price performance is at least 35 percent worse than it was during the 13 weeks before that (excluding the most recent four-week portion)
The risk-alert scores that appear on the site for each company are determined as follows:
"High" alert means five or six alerts are being triggered
"Medium" alert means three or four alerts are being triggered
"Low" alert means one or two alerts are being triggered; and "None" means no alerts are being triggered.
Don't assume you have to run out and sell stocks that have alerts, even High alerts. The alerts indicate, however, that enough bearish sentiment exists out there to make a review prudent. Note, though, that review might demonstrate that the stock has been oversold based on the bearish sentimnent thereby producing a buying opportuninty. Whatever your decision, at least make sure it's based on a new analysis using up-to-date facts, rather than a buy-and-hold inertia.
Click here to learn more about risk-alert screening and download the spreadsheet template.
Click here for a more detailed discussion of the Sell methodology.
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