With tech stocks continuing their roller coaster ride in the markets, we thought some expertise in how to best deal with them would come in handy. Enter
Steve Biggs, CFA, senior technology industry analyst for Zacks Equity Research.
With projected weakness in the consumer segment continuing, do you see tougher times ahead for tech stocks under your coverage?
Most companies in the IT sector derive the bulk of their revenue from the enterprise market, followed by government and small and medium businesses. Although the consumer has been weak this year, enterprise spending has held up relatively well, and second quarter results confirmed this.
The exception has been that industries that sell to consumers have been weak. For example, companies that sell into the retail industry have shown some weakness. Although consumer weakness could spill over into other areas as well, falling energy prices make me optimistic that consumer spending will improve. In my coverage universe, Apple (AAPL) has the heaviest consumer exposure. Apple has held up quite well given frequent product releases that don't appear to have much sensitivity to the economy.
In what ways is the global economy important in your outlook?
The global economy has provided strength for many multinational companies I cover. Companies such as IBM (IBM) and Hewlett-Packard (HPQ) derive more than half their revenue overseas. Strength in economies outside the U.S. has helped these companies offset any weakness in the U.S. economy.
In addition, U.S.-based companies have benefited from currency translation as the U.S. dollar has fallen in value relative to other currencies. As a result, products are cheaper for customers outside the U.S. Moreover, currency translation has inflated revenue growth numbers from non-U.S. sales. I believe that this is starting to reverse itself as Europe appears to be weakening and the dollar is rising in value relative to European currencies as a result. This was partially behind my downgrade of HP, which derives almost 70% of revenue from outside the United States.
Were there any big surprises regarding quarterly earnings recently reported? If so, do they seem to reflect any larger trends?
Results for the second quarter were relatively good. Guidance for the remainder of 2008 was mixed as some companies remain relatively cautious. I think that surprises were mostly company specific. Dell (DELL) comes to mind as one of the biggest disappointments After posting several quarters of improving results, the company badly missed Q2 expectations.
Trouble occurred for Dell as they took aggressive price cuts in an effort to take market share, but weren't able to keep costs in line with its new pricing. However, IBM and HP are both in the same business and reported very good results for the quarter. Although Dell was able to drive unit volume with its actions, it appears that it will take time for profitability to improve.
Which companies would you consider your top Buy recommendations at this time?
My top pick is OPNET (OPNT). The company has a history of strong growth as technology leader in the market for network and application management software. However, it experienced some growing pains over the past year as the company grew its sales force and made an acquisition, which helped its product offering, but was dilutive to earnings.
While rapidly growing its sales force, productivity declined, and new license revenue suffered as a result. OPNET implemented changes in the way it provides sales people incentives, implemented a CRM package and got rid of less productive sales people. The company has demonstrated improvements and is still trading at a very attractive price considering it is a leader in a rapidly growing market.
Although I don't have a lot of new Buy recommendations I continue to like NCR Corp. (NCR) as its financial self services segment is finally gaining traction.
How would you advise investors looking to pick up additional tech holdings in the near future?
I expect continued volatility throughout the rest of the year, so investors are likely to be able to wait for attractive entry points on stocks they like. The global story may be growing long in the tooth given the strengthening dollar and weakening global economy.
At this point I would recommend being selective on stocks as the slowing global economy is likely to be a much bigger problem than the slow U.S. consumer. Companies with new technologies and products, particularly ones that can save companies money, are probably the safest in the current environment.
Steve Biggs, CFA is a senior analyst covering the consumer and enterprise technology markets for Zacks Equity Research.
