It's one thing to talk about reinvesting in solid companies when the chips are down. It's another to actually do it.
Rule Makers Cisco Systems (Nasdaq: CSCO), Intel (Nasdaq: INTC), JDS Uniphase (Nasdaq: JDSU), and Yahoo! (Nasdaq: YHOO) are more than 50% off their 52-week highs. By this measure, the chips are down alright, but that doesn't mean these companies are a steal or that the market simply misunderstands the businesses.
Do you see something the market doesn't? This is a good question for investors to ask. (Fool analyst and writer Brian Graney wrote about this in a recent Fool on the Hill story "Tomorrow's Not-So-Obvious Winners.")
Very short-term movements in stock prices don't mean much to long-term investors. For example, I'm not panicked when Intel trades lower because some analyst doesn't think it can meet quarterly estimates, or the PC industry is suffering through one of its seasonal death rattles.
Longer-term movements however, like the trend we've seen in the Rule Maker Portfolio over the last six months, often occur for very good reasons. It's a rare investor who can see through the veil of misery and understand that a powerful long-term opportunity still exists.
For example, Dell Computer (Nasdaq: DELL) -- which I own -- might have been one of the top-performing stocks of the 1990s, but in 1993 it posted its first (and only) quarterly loss. The company had to cancel plans for a secondary public offering as it wrestled with higher receivables and inventory. A shortage of cash created a working capital crisis.
The company, which was growing more than 100% annually, had to put the brakes on and run a detailed analysis of its business units to determine what was driving profits and losses. Before the cost analysis, Dell didn't know which units were the most profitable and which ate cash. In fact, at this point Dell still sold PCs through fast-growing retail channels like Sam's Club, though it wasn't making any money doing so.
At about the same time, the company's notebook computer unit ran into trouble and Dell had to cancel product lines to focus on a design that worked well and made economic sense. Investors saw the problems and priced the stock much lower. It fell from $49 in February 1993 to about $16 in July (unadjusted for splits). Dell had to change its stripes. Its skill, Michael Dell realized, wasn't designing new technology, but integrating and selling products buyers wanted. Until it got this straight, the company was off the beam.
These aren't trifling problems. Looking back, it might seem like no big deal, but who knew back then that Dell had the mustard to take a hard look at its business and refocus on the most profitable areas? Who knew that by 2000 it would increase sales by a factor of 10 without even doubling inventory? (Dell has $30 billion in trailing sales and carries just $424 million in inventory, compared to 1993 when it had $2.9 billion in sales and carried $220 million.)
Dell solved its problems, learned from its mistakes, and the stock jumped from a split-adjusted $0.25 per share to almost $60, splitting six times over the next seven years. But I can understand why investors bailed during the rough times. It may not have taken a genius to understand Dell would survive, but to knuckle down and reinvest during the lows, it took patience, faith, and an ability, perhaps, to see something the market didn't. I don't pretend that was an easy call.
Fast-forward to 2001. I think the market is asking good questions about the Rule Maker companies mentioned above. Here's a run-down of the issues and my take on whether our portfolio should reinvest in these companies at current prices.
1. Cisco Systems is probably the best company on the planet, but its unrelenting growth can't continue forever and its stock price has been driven by rapid sales growth for a long time. Even at its recent price of $36 5/16 per share, Cisco trades at around 100 times free cash flow and a P/E of almost 100. With sales of more than $21 billion over the last year, Cisco is reaching the point where it will be increasingly difficult to grow fast enough to please the market every quarter. Fortune gives this question excellent treatment in one of its current articles, Cisco: How It Aims To Keep Right On Growing.
2. JDS Uniphase is in the same position: great company, very pricey stock. With less than $4 billion in trailing sales, JDS can stretch growth rates for a while, though the slowing economy is cooling things off. Management finally came out this quarter and acknowledged growth is slowing as vendors put the brakes on capital spending. Over the long haul, there's no company better-positioned to stand on top of the optical components industry, a market with luminous growth potential and high barriers to entry. But, at a market value of $55 billion -- much higher than tested, profitable firms like Charles Schwab (NYSE: SCH) and Applied Materials (Nasdaq: AMAT) -- it's not a tempting buy, even though it's down more than 60% from its 52-week high.
3. Yahoo! is in a different position from Cisco or even JDS. It's clear how Cisco makes money and how it will make more money. Even though slower capital spending means slower growth for JDS, the company isn't looking for ways to secure a revenue stream. Plunging ad rates and skepticism regarding the value of online advertising have put Yahoo! in a position Rule Makers rarely find themselves.
I have no doubt Yahoo! will survive, that its brand name and network will keep competitors at bay, but the profitability characteristics of Yahoo!'s business changed right before our eyes. Until these characteristics become clear, at least to me, I wouldn't be comfortable investing additional dollars.
That said, recent days have brought a couple of positive developments for Yahoo! First, Walt Disney (NYSE: DIS) announced yesterday that it will close its Go.com portal. That's one less competitor for Yahoo!, which supports the argument that Yahoo! will use this tumultuous period to increase market share.
Second, a new, more-promising standard for online advertising may be on the not-too-distant horizon. Recently, CNET Networks (Nasdaq: CNET) unveiled an enlarged ad box that it calls the "messaging unit." The messaging unit provides more animation and graphics, while also allowing the user to interact with the advertisement without being transported to an advertiser's site. Whether the messaging unit is the future of Web advertising or not, this development goes to show that there will be innovations to make Web advertising more effective, and therefore, more valuable.
4. Intel is yet another outstanding company. But the market is questioning whether it can stand at the center of the technology community as fabless chip designers (those who don't make the chips themselves) create a wide range of new chips, such as DSPs (digital signal processors) for cellular phones; as PC growth slows; and as Intel attempts to diversify into areas in which it has little expertise. With $32 billion in sales over the last 12 months, does Intel offer sufficient business growth to double over the next five years (2x/5y)?
I don't see any easy answers. I do think it will be hard for any manufacturers to beat Intel's efficiencies, regardless of what kinds of chips they produce. I'm willing to bet that the PC industry, while growing slower, will remain a growth industry at least through the transition to 300-millimeter wafers and 0.13 micron technologies, and perhaps much longer. I'm betting Intel's strength in the flash memory market will grow crisply and add meaningfully to its profitability. And, I'm betting Intel will eventually figure out how to participate in markets for chips outside the PC industry, just as Dell figured out how to make a sensible and profitable notebook computer.
Intel doesn't look like a slam dunk, even at a sharp discount to its 52-week high, but the company has enough arrows in its quiver to remain a powerhouse.
And finally, this morning Nokia (NYSE: NOK) reported Q4 2000 earnings that met analyst expectations with sales growth of 46% and EPS growth of 39%. Despite the strong growth, shares fell as the company ratcheted down future growth expectations a few notches for the next two quarters. We'll take a closer look at these earnings in the near future. For now, please see Nokia's Q4 earnings release and our Fool News coverage, Nokia Lowers Expectations.
Have a great day.
