Market Watch : Software’s Hot Prospects

If the 1967 film “The Graduate” were remade today, the famous line about plastics being the future probably would be replaced with a line about software. Only it wouldn’t be a joke.

Money managers generally agree that computer software companies are going to be the best high-tech stocks to own in the 1990s. That was re-emphasized last week at the 18th annual Hambrecht & Quist high-tech stock conference in San Francisco.

As computer hardware gets cheaper and cheaper, more computing power is ending up on more desks--and factory lines--around the world every day.

And unlike the hardware field, which has become more of a commodity business, software is much more of a value-added business: We’re using computers in so many new ways that writing software to meet those specialized needs often is more art than science. So customers don’t easily abandon a supplier. “Once people get into a software system, they tend to become entrenched, so the business continues for the supplier,” notes Dan Leonard, manager of Financial Programs Technology stock mutual fund in Denver.

Still, software stocks hardly are immune to problems. Look at Torrance-based Ashton-Tate, a high flier until it found bugs in its dBase IV database management software last year. The replacement costs have put the firm in the red. CEO Edward Esber quit last week. The stock has plunged to $11 from $24 last year.

A software investor “has to look very carefully at the potential size of a firm’s market, how saturated the market is, the key players and how strong the firm’s distribution network is,” said David Bayer, analyst at Montgomery Securities in San Francisco. While he agrees that software overall holds great promise, you have to closely monitor any software company you own, he said.

Personal computer software king Microsoft is one of few stocks that Bayer says is a “buy-it-and-forget-about-it” long-term holding. But he also sees value in stocks such as Aldus (desktop publishing software) and Lotus, another PC software giant.

If you’re a PC buff, you’re ahead of other investors because you have a better feel for software trends. Otherwise, Bayer suggests that a good way to play software is via a mutual fund specializing in tech. Some good performers in recent years include Leonard’s fund, T. Rowe Price’s Science & Technology Fund (Baltimore) and Franklin Dynatech Fund (San Mateo).

A SOFTWARE SAMPLING

How some major software stocks have performed this year.

1990 Stock Friday change P-E* Software Toolworks 15 1/2 +108% 26 Adobe Systems 41 +102% 20 Aldus 22 1/4 +44% 15 Microsoft 61 3/4 +42% 24 Cadence Design 26 1/4 +24% 18 Computer Assoc. 13 3/4 +10% 15 Lotus 33 3/8 +8% 14 LEGENT 24 -9% 14 Ashton-Tate 11 -10% --

* P-E: stock price-to-earnings ratio based on 1990 calendar year estimated earnings per share (Hambrecht & Quist Inc. estimates)

Low Tech, High Profit? A few non-tech firms made presentations at the H&Q; conference last week. One was Dreyer’s Grand Ice Cream. The firm made a big impression on 500 money managers with free samples of its new American Dream line.

American Dream is a cholesterol-free, 98%-fat-free ice cream. The taste is sensational. The only question is how much American Dream will cannibalize Dreyer’s other lines, such as its frozen yogurt.

Barbara Dirvin, analyst at William Blair & Co. in Chicago, estimates that 40% of Dream sales will come at the expense of Dreyer’s other lines. Even so, she said, Dreyer’s has so much going for it that “my confidence in their earnings (power) is very high.”

Oakland-based Dreyer’s makes money off more than just its own ice cream. Its distribution network also is a major plus. Over the past year, Dreyer’s bought the New York City distribution rights for Ben & Jerry’s ice cream and the Dove International (Dove Bar) distribution rights in Chicago. In August, Dreyer’s will begin shipping products to Japan for the first time.

H&Q; analyst Joe Arsenio sees revenue reaching $280 million this year and says Dreyer’s will enjoy “an embarrassment of riches” in 1990 from its marketing coups. Dirvin agrees, and she estimates that earnings per share will reach $1.65 this year (versus $1.38 last year) and $2 next year. What’s more, she said, the company “learned a lot” from distribution snafus in the late 1980s that hurt earnings and kicked the stock down.

At $34.75 on Friday, Dreyer’s stock is at an all-time high. The company’s goal is to grow earnings 25% a year. Though any bet you make at the current lofty stock price better be for the long term, Dirvin says, Dreyer’s is a high-quality way to profit from the world’s unending love affair with ice cream.

COOL STOCK: Dreyer’s Grand Ice Cream, high price each year, in dollars per share. Friday: $34.75

Source: Standard & Poor’s