New concerns arise over Net stocks

That statement was often heard while describing the new business models and valuations ascribed to many "new economy" stocks over the past few years, especially when defending their rise and predicting continued upward stock price trajectories.

And while much of the volatility we have seen over the past year has been due in large part to the deflation of these valuations--a normalization of P/E (or price/sales) multiples-today, investor concerns are different.

More and more, concerns are emerging over earnings outlooks and fundamental drivers of demand in technology segments, and the fear is that the disappointments in third-quarter earnings reports displayed by many technology bellwethers are a forewarning of a slowdown and missed expectations in 2001.

In my view, this concern is warranted. Almost all the PC companies I follow have issued either disappointing financial results or lowered their expectations for the year to come. And with the PC market at roughly $100 billion, driving the fortunes of many component suppliers, distributors and manufacturers, any slowdown here has widespread repercussions.

Don't get me wrong. Many analysts for some time have seen a slowdown coming in PCs. Saturation on the desktop, the lack of compelling reasons to upgrade, and the rise in dedicated Internet appliances--all factors that aren't new--have been contributing to a slowdown. Nevertheless, consensus expectations in mid-summer were for a rebound in growth-a rebound that today appears subdued, at best.

PC fundamentals are not the only concern. Telecom spending, dot.com funding and demand in Europe are all uncertain and adding to investor jitters. What's also important to note is that much of this demand slowdown is on the margin. PCs, for example, are expected to continue to grow but not as much as earlier forecasts suggested. Telecom spending is at risk in some segments, but few expect large-scale cutbacks. And though the buildout of the Internet continues, fears over the 10 percent to 15 percent of business related to struggling pure dot.com companies are first and foremost.

Finally, the expected seasonal year-end strength has failed to emerge this year. Traditionally, budget-driven customers spend heavily in the fourth quarter, adhering to the "spend it or lose it" capital budgeting process. This strong demand has usually been reflected in strong financial performance. While it is too early to predict the outcomes of the suppliers' fourth quarters, I believe the widespread strength will not be repeated this year.

But not all is bleak. PCs may not be growing as fast as previously thought, but devices such as the Palm or RIM pager are still proliferating. It's my view that the Internet is still in the early stages, and both the network and storage fields have strong business prospects.

So what's an investor to do?

First, align your own expectations with the fundamentals of the segment. Don't expect a sudden rebound at year-end. This time it's different.

However, look through this period, as I believe 2001 will offer new investment opportunities, especially as consensus becomes too pessimistic on growth.

I particularly like Network Appliance and Veritas, which Deutsche Bank Alex. Brown rates "strong buy" and "buy," respectively. Both have strong fundamentals, both provide key building blocks for the Internet, and their valuation has pulled back recently. Computer systems and PC stocks may also become more attractive on a valuation basis, but I prefer to be on the sidelines in that segment until fourth-quarter reports are in.

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Deutsche Bank Securities Inc. maintains a net primary market in the common stock of Network Appliance, Inc. Within the past three years, Deutsche Bank Securities Inc. or its wholly owned subsidiary, DB Alex. Brown LLC, has managed or comanaged a public offering of Network Appliance, Inc. The following stock(s) is (are) optionable: Network Appliance, Inc. There is a (are) convertible issue(s) outstanding on Network Appliance, Inc. Deutsche Bank Securities Inc. maintains a net primary market in the common stock of Veritas Software Corporation. The following stock(s) is (are) optionable: Veritas Software Corporation. There is a (are) convertible issue(s) outstanding on Veritas Software Corporation. An author of this comment has a long position in the common shares of Veritas Software Corporation.