Market Wrapup (10-09-2003)

As the Generals in the last secular bull market, large cap NASDAQ technology stocks led the way. They are also the leaders of the latest rally that began in October of 2002 based on market capitalization gained. I thought it would be relevant to examine a representative company, Intel, from a fundamental perspective. Following the fundamental analysis of Intel, I evaluate the technical charts of five of the leading large cap technology stocks, to gain insight into their short-term stock prospects.

Any fundamental analyses should be tempered by what's going on in the current market. In today's speculative market, a correct fundamental analysis is usually of no value in the short (days to weeks) or intermediate (weeks to months) term. Any fundamental analysis applied to stock market valuations is difficult; because the analyst can either prove to be wrong by being right and early, or just plain wrong. Consider the fundamental analysts who suggested that the NASDAQ was way overpriced at 3,000 in the late 90s, only to see it go to over 5,000. Someone investing with their correct fundamental convictions only and no stop loss would have faced serious margin calls. During the subsequent bear market, they would have gotten their redemption from the ground floor of the Poor House. Technical analysis can provide practical insight into when and how a stock will move in the short and intermediate term. In the intermediate or short term, a bad fundamental analysis can be saved by a good technical analysis. My intent is to find a rational for buying, selling, avoiding, or shorting these stocks.

Table 1 below, outlines key fundamentals of selected large cap growth stocks. Selected S&P 500 data are also included.

In terms of trailing P/E, Intel, Cisco and Dell trade at trailing P/E premiums to the S&P ranging from 1.3 to 1.8. However, Wall Street analysts are projecting 5-year growth rates of 15% for these technology stocks. The optimistic growth rates of S&P companies currently average about 9 or 10%. Oracle actually is projected by Wall Street to grow at a slower (10%) rate over the next 5 years compared to other technology companies. The slower growing Oracle trades at a multiple similar to the S&P. Therefore, the expanded multiples afforded by the market for large cap tech stocks appears to correspond to the faster projected growth rates. If there is a 'love premium' for tech stocks, the love is baked into Wall Street's projected growth rates.

As an example for most large cap technology stocks, I would like to examine whether Wall Street's valuation and 5-year growth projection of 15% for Intel is believable.

Figure 1 below summarizes historic sales, earnings, and shareholder's equity for Intel Corp. from 1993 to the present.

Intel posted impressive sales earnings growth from 1993, to 2000. From '93 to '98, the sales growth was steep and linear. From '98 to '00, the growth was even steeper. Intel also maintained their sales at '98, '99 levels through the economic slow down in '01, and '02. Analysts are projecting that this year's sales will be roughly equivalent to those in 2000, and earnings will be about 65% of the 2000 levels that occurred at the height of the technology bubble. The corresponding forward P/E ratio of 28 is still expensive though. A relevant question is, at what rate will Intel grow in the long-term future? The 15% 5-year growth rate predicted by Wall Street analysts implies that sales and earnings at Intel will double in 5 years. If Intel were to successfully grow sales and earnings at 15%, today's Intel stock price is 14 times its projected 2008 earnings. But if Intel grows at only 10% rate over the next 5 years, then today's Intel stock price trades at 17.4 times its 2008 earnings. Its difficult for me to believe that Intel, a company that has actually shown shrinkage in sales and earnings over the last 5 years, will grow sales and earnings at an average of 15%, doubling over the next 5 years.

For comparison purposes, Wall Street expects Johnson & Johnson (JNJ) to grow at a 13% annual rate for the next 5 years. If JNJ succeeds as they have in the previous 5 years, then JNJ trades at 12.8 its 2008 earnings; a 9 percent discount to Intel's rosy forecast, and a 36 percent discount to Intel's more realistic earnings growth rate of 10% per year. JNJ has posted consistent growth over many years and a variety of economic conditions. Intel, although achieving impressive growth in its formative years, has had difficulty during the recent economic soft patch. Intel now is a mature company that is affected positively and negatively by economic conditions. This is not reflected in rosy Wall Street forecasts that predict a 15% annual growth rate for Intel.

If Intel were at the beginning of a 5-year run of world-class growth, it would not have stumbled as much as it did over the last few years. If their products were so necessary for their old economy customers to compete, don't you think they would have posted some growth and not shrinkage over the last few years? If new Intel products were needed for companies to compete, they would have purchased them in spite of the economy, especially with the past and current accommodative monetary policy. Do you think that corporations are thinking that as soon as the economic soft patch ends, they are going to get out there and replace most of their computers? I don't. These companies are facing pressure to clean up their balance sheets, and pay dividends to their shareholders. Unless expenses for new technology and computers can bring an immediate return on investment, they will be deferred or eliminated. When Intel posted exponential growth in the mid-90s, corporations needed new computers to compete. Failure to innovate via technology would have been fatal to most companies. Accordingly, companies purchased technology with a strong sense of urgency. Their survival depended on it. Now, with technology an integral part of practically all businesses, further innovation is discretionary in most cases. The Pentium II purchased in 1997, and the Pentium III purchased in 1999 is adequate for 95% of the tasks utilized in most business applications. I'm typing this and viewing Financialsense.com on a Pentium III, purchased in 1999.

The government checks, recent tax cuts, and home refinancing are driving current growth in household computer sales. These sources of spending money are not sustainable as a revenue source for Intel. On the household level, once the unsustainable economic stimulus wears off, sales of computers to consumers will inevitably slow.

In the late '90's, technology companies such as Intel also benefited from Initial Public Offering (IPO) money sloshing into computer and other technology purchases needed for dot.com startups. Unless such an IPO bubble wheel spins again, future sustainable growth of this nature will not return.

It is true that sales and earnings in the short term have grown for Intel as well as most large cap technology companies. In most cases, this is a result of the adrenalin rush injected into the economy through monetary stimulus. However, the market is looking at this adrenalin rush-induced growth and believing that all is in place to produce late-90's sustainable tech stock growth rates into the foreseeable future. Intel is now a mature company, and it is inevitable that its growth will have to come in smaller percentages. Accordingly, technology growth should mirror the overall economic growth rate in some fashion. I think the long-term growth estimates of 15% will come down, along with the P/E multiples for Intel and others. When this will occur is difficult to say in the current speculative stock market environment. There are still a lot of better-than-expected and beat-by-a-penny earnings announcements and pre-announcements on the horizon for large cap tech stocks. In most cases their managements are cooperative experts at playing their part in the Wall Street game of 'Speculation'.

I think that similar fundamental reasoning also applies to shares of Cisco, Dell, Oracle, and Microsoft. If you e-mail me, I will send you spreadsheets and graphs that are similar to what is presented for Intel, above.

I'll leave the fundamental analysis with one important observation. Except for Microsoft, these companies rely on stock options as a major component of employee compensation. Should the company stocks correct significantly, these companies would have to either re-price options, or compensate key employees with real cash. In a down market, even the gullible public will not stand for re-pricing of stock options without further punishing the stock. Cash compensation would likely be needed in place of options. Cash compensation would increase operating expenses and decrease the bottom line. This in turn, would have a 'ripple' effect in the stock market. It could be a catalyst for a rapid stock market fall for several of these richly valued companies. Now let's look at the technical charts.

Following are technical analyses of the charts of Intel, Cisco, Dell, Oracle, and Microsoft.

I would not recommend taking a position in Intel at this time; however, I would hold a long position in spite of my long-term fundamental view. The Intel chart is at a lower high. However, it may have already broken through this trend line. This has not yet been confirmed, so that Intel seems to be at 'the crossroads'. Since it has advanced on higher volume, it would not be a good time to short this stock. If Intel has broken its downtrend, then it should have room to move higher. If the downtrend remains intact, we should know soon enough.

As with Intel, Cisco is also at 'the crossroads'. However, Cisco is looking weaker technically. I would sell a long position, and consider shorting at 20 and change. There is clear resistance in the low 20's. What is interesting is that Cisco is approaching this resistance for the third time. However, each successive time the resistance was approached, the upside volume decreased. Technically, this would suggest a good entry point for shorting, with a stop loss at about 22.

The price action for Dell is manic. This action is not healthy and for this reason, I wouldn't recommend being long Dell. 34 and change is an excellent technical exit point. However, the resistance at 30 may have been broken (on diminishing volume though), and shorting could be dangerous. Shorting Dell with a tight stop loss may provide a good risk reward ratio, although there are better positions to take in other stocks.

The chart of Oracle is in a clear long-term downtrend. The failure to break through the trend line and its subsequent decline on high volume is a bearish sign. Oracle may be a good technical short, with a stop loss slightly more than 1 point above the trend line. Of course, any tech stock is subject to a positive press release. If Larry Ellison says something like, 'it feels like a bottom', or 'things appear to be brighter' on cable, you could be looking at an immediate 15% paper loss. It's happened before! In this speculative environment, an analyst upgrade is also a distinct possibility. They are at it again! Don't short Oracle with the utility bill money.

Microsoft is in a long-term downtrend. Unhealthy manic price action is also apparent with Microsoft. As it approaches the upper trend line, volume is successively decreasing. This shows that the (down) trend line will likely stand. It's a good time to sell long positions in Microsoft. Microsoft at 29 would be a safer short than Oracle, although the potential reward would not be as great.

In summary, I think the Wall Street growth projections for large cap technology companies such as Intel are too optimistic based on demand for their products and economic conditions. Valuations are too high and will have to be lowered at some time.

The technical charts show large cap technology stocks at the top of a long-term down trend in many cases. The immediate future for tech stocks will be established by whether the long-term down trends remain intact. Intel appears to be the strongest of the five stocks considered, while Oracle is the weakest. If the downtrends are broken with gusto, technical analysis suggests that these stocks will likely go even higher. But in general, volumes are diminishing as the stocks (Oracle, Cisco, and Microsoft) approach their long-term down trend's resistance levels.

Yahoo reported $0.10 per share of earnings. Yahoo's diluted share count between the second and 3^rd quarter increased by about 8.9 million, amounting to a stock market value of about $388 million. Gee whiz, the market value of the 3^rd quarter share dilution is almost 6 times the $65 million that Yahoo earned in the 3^rd quarter. Had there been no share dilution, the EPS would have been $0.104, or the same $0.10, rounded. Amazing. The options actually were free on a reported EPS basis! But lets not quibble about such trivia when there is such a compelling reason to buy or hold Yahoo. 'This baby is goin' up!'

The one-year daily chart of Amazon.com below indicates a well-defined upper channel line dating back to January of this year. Amazon appears to have entered into a parabolic 'climax run' breaking above this upper channel line. Today's buyers of Amazon are finding something so compelling in Amazon, that it warrants panic buying, even after a 300% run-up in the last year. I wonder what the rest of us missed that these buyers are finding in the last 5 days? Today's action in Amazon could be an exhaustion gap.

Happy talk from Yahoo, and the weekly jobs report below the 400,000 'magic number' was enough to gap the market higher, and ignite a 1999-2000 style NASDAQ party. (Last week's jobs report was revised above the magic number.) The party was in full swing in the morning, but by about 1:30pm Manhattan time, someone removed the punch bowl. All indices were up marginally having given back most of the morning gains. Conspicuous in their absence when the party officially ended at 4pm were the technology generals Oracle, Intel, Cisco, and Microsoft. Oracle was down 2.4 percent and the others were little changed. These generals are looking relatively weak, in comparison to the smaller more speculative names.

The 10-year bond was down by about 1.4%; gold and silver were marginally higher after making an afternoon comeback.

Thanks, lelio.

The WSJ published an editorial today suggesting the GSEs be nationalized (!!!) since Congress lacks the will to make them truly private.

The OFHEO (Fannie's alleged regulator) is looking to hire an accountant capable of explaining Fannie's books to them.....What the Hell have they been doing for the last 10 years if they can't even understand the books?

The WSJ published an editorial today suggesting the GSEs be nationalized (!!!) since Congress lacks the will to make them truly private.

Let's see... GSE revenue and assets in the neighborhood of $6T, being managed by the same folks that brought you the Social Security lock box....

In fairness to OFHEO, the accountants that could explain Fannies books have been indicted for fraud and/or have gone out of business. :-D

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.

Company	Symbol	Market Cap. (Billion)	Trailing P/E	Trailing P/E Premium To S&P	Forward P/E	5-YR. Projected Earnings Growth Rate (%) (Reuters)	Dividends (%)
Intel Corp.	INTC	193	54.8	1.88 X	28.0	15.0	0.28
Cisco Sys.	CSCO	144	41.5	1.45 X	28.6	15.0	0.00
Dell	DELL	89.5	38.4	1.34 X	28.0	15.0	0.00
Oracle Corp.	ORCL	62.6	26.6	0.93 X	22.8	10.0	0.00
Microsoft	MSFT	316	31.6	1.10 X	24.4	10.5	0.55
S&P 500	--	--	28.7	1.22 X	26.3	10.0	1.72