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Profit from the Fear
By: David Sterman
Investors tend to buy stocks when the market is on the upswing
and avoid them when the market is flashing red. But if you focus
simply on value, then you should be buying at lows. And right now,
a whole host of stocks are trading at lows for the year, even as
their prospects have materially brightened since 2010 began.
This is especially true for "high beta " stocks. These stocks tend to move in an outsized fashion, so when the market falls by -1% or -2%, these stocks can fall at twice that rate. Ironically, high beta stocks, most notably tech stocks, have recently produced stellar profit gains, thanks to strong cost cuts and moderate sales gains.
Further sales gains should lie ahead. That's because many companies are only now starting to adopt the latest version of Microsoft's Windows operating system. And that upgrade also typically triggers a nice upgrade cycle for hardware and other office equipment. Moreover, we're in the midst of a second technology revolution as mobile devices harness the power of the Internet in ways that seemed unfeasible just a decade ago. Chip makers are working furiously to develop new wares to power devices that will hit the market in the next few years.
So as we head into the weekend, here's a short list of tech stocks that are being dragged down in this maelstrom, are at or near lows for 2010, still look set for improved results in the quarters and years to come, and have very strong balance sheets. If you've got some downtime this weekend, these stocks are certainly worth further research.
Seagate Technology (Nasdaq: STX)
This maker of hard disk drives has posted an impressive turnaround thanks in part to streamlining efforts and in part to rising demand for computers and servers. In fiscal (June) 2009, Seagate Technology was still feeling the effects of the global slowdown, losing $0.36 a share. Yet in the fiscal year that ends this month, per-share profits are likely to surge past $3.50. That would be the company's best showing in the past decade.
Yet Seagate is getting little credit for the upturn, as shares trade for less than five times earnings. That's because investors are fretting that the company will soon have to cut prices as industry supply catches up with demand. That concern has actually been in place for quite some time, which has enabled Seagate to handily exceed estimates in each of the last four quarters.
Right now, analysts think shares will stay stuck in the $3.50 range for a while to come. But assuming PC and server demand continues to build during the next few years, Seagate's current efforts to expand capacity should push sales and profits higher in 2011 and 2012 as well.
Investors should also take note of the more than $2 billion in cash sitting on the company's balance sheet . The company could apply $1 billion toward a buyback that would remove about 60 million shares from the market. That move alone would boost earnings per share by +15%, all other things being equal.
Applied Materials (Nasdaq: AMAT)
Also in the technology sector, Applied Materials has fallen below levels seen at the start of the year, even as analysts have steadily boosted their estimates. AMAT has strengthened its position as the world's leading provider of semiconductor fabrication equipment. It's a very profitable business, and poised for growth in coming years as major chip makers make up for recent years when they under-invested in chip-making equipment. Trouble is, AMAT also moved into the solar panel making business, and has nothing but losses to show for those efforts.
Management has recently taken steps to cut costs in this division, which should allow the robust profit picture in the semiconductor division to become more apparent on the bottom line . And during the next year or two, management believes that the solar unit will actually start boosting profits instead of weighing them down. It's also worth noting that AMAT is sitting on $2.3 billion in cash, another $1.2 billion in long-term investments and carries no debt.
Electronics for Imaging (Nasdaq: EFII)
Electronics for Imaging is also now below its January 2 level, and yet earnings estimates have recently risen. The company has a long-standing reputation for state-of-the-art printer and copier engines that are used by major manufacturers such as Canon ( CAJ ) and Ricoh. The company has little control over its business and must simply wait for those blue-chip customers to secure more orders for new printers and copiers.
The good news: printers and copiers wear out, and the upgrade cycle has begun in earnest. That's why analysts have been steadily boosting profit forecasts, and now think EFII will earn around $0.38 a share this year, up from a loss the previous year. This is a business with huge fixed costs, thanks to heavy R&D spending, so a little revenue growth goes a long way. Sales are expected to rise +10% next year, which should allow profits to double to around $0.80.
EFII has always had a very strong balance sheet, and has recently used its cash to buy back stock. The share count fell from 68 million in 2007 to a recent 49 million. With another $200 million still sitting in the bank and EFII now generating more robust cash flow , ongoing buybacks should take the share count even lower in coming quarters. If the company spent another $100 million on buybacks, eight million shares -- or 15% of the float -- would be removed. That would help boost earnings-per-share growth rates at a time when demand for printers and copiers is on the rise.
Action to Take --> Rising estimates and lower stock prices always make for better price-to-earnings ratio (P/E) multiples. And with bullet-proof balance sheets, these companies can benefit by supporting their stock through strong buybacks. At a minimum, these balance sheets help provide a floor at a time when investors want to know the downside.
-- David Sterman
Disclosure: David Sterman does not own shares of any security mentioned in this article.