Tech may face critical moment
The computer and telecom networking equipment made by Cisco Systems Inc. moves untold amounts of data, images and video around the world every minute.
A bigger challenge for the company may be moving its stock above $30 even for a day.
Cisco’s shares haven’t closed above that level since 2001. They got near it Jan. 12, when they finished the session at a three-year high of $28.92, after rallying 68% since early August.
But Wall Street pulled the plug on Cisco and many other big technology stocks last week. The title of a Banc of America Securities research report downgrading Cisco’s shares summed up the turn in sentiment: “We believe it’s as good as it gets,” wrote analyst Tim Long.
Cisco ended Friday at $26.70, down 7.7% from a week earlier.
This may prove to be a critical juncture for the tech sector. Investors have high hopes for the industry’s earnings growth in 2007, assuming the global economy stays healthy. A lot of money has moved into the sector’s stocks in recent months.
Since the tech bust of 2000-02, however, people have been reluctant to stay upbeat about the industry’s growth outlook for very long.
That’s understandable considering the massive losses investors faced in the bear market that followed the wild tech boom of the late 1990s. Won’t get fooled again, as the song goes.
To that point, the revelations about stock-option pricing abuses that have rocked the industry since spring obviously haven’t been a confidence booster. Tech isn’t the only industry implicated, but the only federal charges filed have been against tech company executives.
Skepticism also makes sense given that the industry as a whole isn’t the growth machine it was in the last boom -- even though the global economy since 2003 has been having its broadest and strongest expansion in more than three decades.
Demand for tech equipment is good, in some cases great, depending on the product. Apple Inc., with its Macs and iPods, has been an industry standout for four years.
Dolby Laboratories Inc.’s shares rocketed from $20 in November to a recent high of $33.96, after the company reported a 50% jump in fiscal fourth-quarter earnings.
Demand for Dolby’s high-fidelity sound technology is rising rapidly in industries including computers, TVs and autos, says David Carlsen, a co-manager of the Buffalo Science & Technology stock mutual fund in Shawnee Mission, Kan.
But for many tech companies, making decent money even off good demand is tough. A world full of capitalists is a world full of fierce competitors.
The pullback in tech shares last week was triggered in part by computer chip leader Intel Corp.’s fourth-quarter earnings report Tuesday. Locked in a ferocious war for market share with Advanced Micro Devices Inc., Intel said its quarterly profit plummeted 39% from a year earlier.
“There’s still too much capacity out there” in chip manufacturing, Carlsen said. “Either demand is going to have to pick up or capacity” will have to shrink.
After pushing Intel’s shares up from $16 at midyear to $22.30 just before the earnings report, Wall Street wasn’t in a mood to be disappointed. Intel ended Friday at $20.82, down 6% for the week.
Stocks had rallied across the sector since midsummer as investors’ mood brightened. Faith that the U.S. economy would continue to expand in 2007 has lifted hopes for robust business capital spending. Consumers’ embrace of technologies such as high-definition TV also has helped buoy tech shares.
With oil prices sliding, the energy industry has lost its place as the leading sector for earnings growth. That, too, has brought hopeful investors back to tech.
But we’ve seen this movie before. For tech shares overall, rallies have been short-lived affairs since the initial rebound in the stocks in 2003.
Volatility is in the DNA of these stocks, of course. Still, little net progress has been made over the last three years: The tech-dominated Nasdaq composite index has risen 14% in that time. By contrast, the average stock on the New York Stock Exchange has gained 38%.
The struggle to maintain upward momentum in many tech issues naturally means analysts and investors grow more antsy once a rally begins. That feeds the don’t-stay-too-long mentality -- the opposite of the 1990s, when investors’ biggest fear was selling too early, Carlsen notes.
What’s more, Wall Street analysts don’t want to be accused of their great sin during the last boom, which was over-hyping the tech sector’s prospects.
Analysts “aren’t playing the cheerleader role they played in the 1990s,” said Edward Yardeni, head of Yardeni Research Inc. in Great Neck, N.Y.
When Banc of America Securities and two other brokerages downgraded Cisco shares last week from “buy” to “neutral,” all three cited concern that the stock’s rally since July was fully reflecting the company’s near-term earnings growth prospects.
Merrill Lynch & Co. analyst Tal Liani, for example, figures Cisco’s sales will reach $34.3 billion in the current fiscal year, up 20% from the previous year, and that earnings will rise 21% to $1.15 a share.
That gives the stock a price-to-earnings ratio of about 23 -- more expensive than the average stock, to be sure, but not relative to a lot of other tech issues.
Yet most of Cisco’s growth is coming from networking businesses that don’t have huge profit margins, Liani said. That means there’s little potential for Cisco to surprise investors with better-than-expected earnings in the near term, he said. And pleasant surprises often are what it takes to draw hordes of new investors to a stock.
The calendar also is working against the tech sector. Historically, it doesn’t fare well in the first half of the year. Its rallies tend to occur in the second half.
All of this is frustrating for any investor who would prefer to think longer-term about Cisco and other tech shares.
“I’ve never seen the company as enthusiastic about their future as they are now,” said Walter Price, co-manager of the Allianz RCM Technology stock fund, which has a stake in Cisco.
The world wants more and more delivered over the Internet -- data, voice, video, etc. The network has to expand, and that’s what Cisco sells: a bigger, broader, faster network.
Burgeoning services including online gaming and Internet telephony “are soaking up capacity on the Web,” Carlsen says. That is forcing telephone and cable companies to spend more on system upgrades.
That’s true here and abroad. Just 10% of Cisco’s sales come from emerging-market countries such as China and India, according to BofA Securities’ Long. Those countries now are a major focus of expansion for Cisco, Chief Executive John Chambers has promised investors.
The issue is whether domestic and foreign growth will come fast enough, and be profitable enough for Cisco, to make investors feel confident about extending their time horizon from months to years.
From 1991 through 1999, Cisco shares rose every year. No one expects those glory days to return, and rightly so.
In this decade, Cisco shareholders have yet to see even two positive years in a row for the stock.
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