Posted 3/24/98
Goodbye, PC Stocks (Sniffle)
Let's remember the good times. The growth, the earnings, the glow. It was beautiful, but it's over.
By Jim Jubak
Dear PC stocks: We need to talk.
We've had great times together these last 15 years. Whatever spats we had, I knew my portfolio couldn't get by without you. In fact, I just couldn't get enough of you.
But it's over. I hope we can still be friends. A few of you will always have a place among my investments. But, well . . . the thrill is gone. It's time to move on.
Readers of this column know that I don't give up on a sector easily. In fact, I probably stick with a favorite stock that's in trouble longer than I should. So I hope you believe me when I tell you that it's not the recent warnings from Compaq (CPQ) or the depressed price of Intel (INTC) that has led to this change of heart.
As I read through my columns for the past nine months or so, I realize that I've been moving toward this conclusion for a long time. For the last 15 years or longer, PC companies from Apple (AAPL) to Intel to Microsoft (MSFT) to Compaq have been the most exciting and profitable technology stocks to own. Technology investing was, in good part, PC investing. (Investor is published by Microsoft.)
Going forward, the big opportunities will come from investing in communications stocks.
Of course, the PC isn't going away any more than the mainframe or the workstation has gone away. Investors will still make profits -- often very good ones -- from investing in Intel just as they have from investing in IBM (IBM) and Sun Microsystems (SUNW).
But the big opportunities, the profits that come from major shifts in how we live and how companies run their businesses, will come from investing in communications stocks.
I've made a lot of very sweeping generalizations in these opening paragraphs and I certainly don't have room in the remainder of this column to even list all the exceptions and caveats. I certainly can't describe how I think this conclusion affects every PC company. That will take column upon column over the coming months. Here, though, let me explain how I've come to this conclusion and what I think it means for the way you should build a technology portfolio.
See Intel's 3/19 announcement on price cuts Intel's March 19 announcement of its latest round of price cuts finally forced me to rethink my relationship with PC stocks. "Intel Corp. said that it cut the price on its fastest version of the Pentium II processor by 19%," the news story reported, "in order to stimulate more demand at the high end of the market."
Of course, heavy price-cutting has been a fact of life in the PC industry for the last year. Compaq cuts prices, IBM undercuts those bargains, Hewlett-Packard (HWP) weighs in even lower, Dell (DELL) takes the market down again. And price-cutting isn't limited to the PC part of the technology world. The prices of the low-end routers that steer traffic on the Internet have fallen almost as fast in the last nine months. The prices of wireless-telephone handsets are falling even faster.
But there's something different about this price cut from Intel. It's not designed to reduce a temporary buildup of inventory. It's not just an attempt to defend market share against competitors -- although the price cuts certainly don't help Advanced Micro Devices (AMD) or National Semiconductor (NSM). It's certainly not an attempt to clear out older products to make way for a new generation of technology.
When you come right down to it, Intel is cutting prices because consumers don't have a compelling reason to buy its newest products. Think back to the kind of rabid buying that used to greet a faster Intel chip or a new operating system from Microsoft. Know anybody who really can't wait for Windows 98? Demand in the PC industry has matured.
That's not the end of the world. I happen to agree with those analysts who say that PC sales will grow at 12% to 15% next year. A lot of CEOs in other industries would sacrifice their right arms for growth like that. And I don't see growth falling much below that rate any time soon. Outside the U.S., the world is woefully under-PCed. Companies like Intel, Microsoft, Hewlett-Packard, and IBM are pushing new technologies that will give some consumers reasons to upgrade. And the costs of making the components of a PC, everything from the hard drive to the microprocessor, are falling.
Some PC companies are going to do just fine in that environment. In fact, I can even tell you what they'll look like. They'll be big and financially strong or extremely profitable niche players with unique products -- they'll have to be so they can afford to invest in a new generation of factories every three to seven years. They'll be misers when it comes to costs, squeezing the last cent out of manufacturing and marketing. And yet they'll invest heavily in the specific factors that give each company its edge -- whether it's state-of-the-art manufacturing or cutting edge marketing.
The market already thinks of Hewlett-Packard as a blue chip. It's time to think of Intel that way too. I'd want a few companies like this in my portfolio for the same reasons that I now want to own Pfizer (PFE) or Gillette (G) or General Electric (GE). The market already thinks of Hewlett-Packard as a blue chip -- it is a member of the Dow Industrials after all. It's time to think of Intel that way too. Is the company's domination of its industry less thorough that General Electric's? And Dell's? Isn't this a great marketing company able to stand comparisons with Coca-Cola Co. (KO)?
Of course, I don't expect blue-chip companies to do too much, either. I don't expect 40%-a-year growth -- they're too big for that and own too much of their markets. I don't expect these stocks to trade at price-to-earnings ratios of 120 or 190. And I don't expect them to return 50% or more a year -- although I'm very pleased when they do report that kind of performance for a short time. Investors who expect Labrador retrievers to outrun greyhounds are asking for disappointment.
Intel's annual return each of the past ten years It's hard to stop expecting that a stock that has raced like a greyhound in the past will continue to perform like one. Intel returned 80% to investors in 1995, 131% in 1996. The company's average annual return over the last 10 years is 35%. I don't expect anyone to be happy with the 7.5% return the stock provided in 1997.
But I also think it's unreasonable for anyone to expect Intel stock to continue appreciating at the 35% annual rate of the past decade. After all, analysts are projecting that Intel's earnings growth will slow by almost 50% in the next five years.
If you want the kind of growth that PC stocks were able to deliver in the past, I'd suggest you look at a different industry all together. Demand for communications services and equipment shows the same kind of pattern that characterized the PC industry not so long ago. Those of you who were investing in the PC industry when it took off might find some of this familiar.
Demand is growing not by 12% or 15% a year, but at twice or three times that rate. For example, in 1995 all the wireless phone companies in the world had just 85 million subscribers. By 1997, according to the Yankee Group, that number was up to 199 million. The market research firm expects 529 million subscribers by 2002 -- a 26% annual growth rate.
The rising number of subscribers draws more and more companies into the field. By the end of 1997, the number of wireless networks in the world had climbed to 687, from 10 in 1982. It's headed for 1,144 in 2000. That drives down prices. The average worldwide price for wireless service dropped by 20% in 1997, according to the Yankee Group. And lower prices pull in even more customers.
The growing size of the market makes it profitable to sell more and more specialized products and services. Companies can afford to sell stock-market information by wireless phones even if they only reach a very small percentage of a 529-million-subscriber market. Consortiums can afford to launch multi-billion-dollar satellite systems just to capture the "roving professional market."
Competition drives innovation in the products offered to consumers, as companies seek ways to differentiate themselves. Lighter handsets with bigger screens. Improved battery life. Voice-activated dialing. Personal electronic assistants to automate routine tasks. Global personal phone numbers.
Competition drives innovation in the infrastructure as service providers try to cut costs by buying more efficient switches or by pumping more signals over existing lines. So what are the names of some of the winners? Unfortunately, here too the communications revolution reminds me of the early stages of the PC industry. Will Ciena (CIEN) be able to leverage a single narrow technology into a complete company? At this stage it could still turn out to be either Microsoft or Kaypro.
Know the ins and outs of SONET ring technology? I don't. Neither do most investors. The first to learn gets the edge. Will some upstart produce intelligent switches turning Cisco's (CSCO) routers into tomorrow's equivalent of DOS? I frankly don't know. Even producing an informed guess is difficult.
Which is why a guess, informed by all the work that an investor has time for, could turn out to be so profitable. It took me 10 years to learn enough about computer technology to feel comfortable investing in those stocks. With the current generation of communications stocks, I'm beginning another learning curve. Know the ins and outs of SONET ring technology? I don't. Neither do most investors. The first to learn gets the edge.
In the last few months I've cut my exposure to pure PC stocks. I still own Intel in Jubak's Picks, but not much else. Texas Instruments (TXN) and LSI Logic (LSI) both have considerable PC industry exposure, but I own them for other parts of their businesses.) As I've learned enough to figure out a few pieces of the communications revolution, I've added plays such as Saville Systems (SAVLY), Tellabs (TLAB), Advanced Fiber Communications (AFCI) and Qualcomm (QCOM).
I'm still in the process of building a portfolio of communications stocks. I'm still near the beginning of learning what might separate the winners from the losers. I invite you to come along as I try to figure out which is which.
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