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2HRS2GO: PC stocks defy industry picture

COMMENTARY--You could sense the pistons churning in the collective engine of PC investors the moment Applied Materials called the bottom.

"We think that the PC market may be near a bottom with the inventories approaching normal levels, and therefore expect the PC market to lead the industry recovery in the second half of this year," Executive Vice President David Wang said during Applied Materials' conference call with analysts yesterday.

But how much of that has been anticipated? PC stocks have already gained this year despite industry trends.

Playing Jeremiah to the PC industry's Jerusalem has been one of the technology world's most popular past-times since last fall. More than a few pundits--including this one--don't like what they see on the long-term horizon for PCs. The U.S. market is saturated, there are no compelling reasons to upgrade to newer technology, and there's little to distinguish one box from another, at least among Wintel vendors.

Last fall saw a sharp decline in PC stocks as those factors hit home, and analysts have cut their ratings. The consensus recommendation on Dell Computer (Nasdaq: DELL), for instance, has risen to 2.14 from 1.97 three months ago on the scale of Zack's Investment Research, whose system rates a "strong buy" at one and a "hold" at three. Compaq Computer (NYSE: CPQ) has seen an almost identical move, to 2.15 from 1.97.

Zack's analyst recommendations for Gateway (NYSE: GTW) and Apple Computer (Nasdaq: AAPL) improved slightly over the same period, but their ratings are still relatively lousy at 2.29 and 2.65 respectively.

PC shareholders couldn't care less. Each of the aforementioned stocks, save Compaq, has outperformed the Nasdaq composite index over the last three months. The difference looks even more dramatic if you look at this year-to-date graph from BigCharts.com:

Box makers aren't the only recipients of market goodwill this year. Look at these PC-related stocks:

Some stocks have specific reasons for their climbs. Advanced Micro Devices (NYSE: AMD) proponents will point to market share against Intel (Nasdaq: INTC). Apple fans would note their company has already paid for last year's missteps involving the Cube; the company could also get an OS X boost as the year progresses and more applications become available for the new operating system.

However, you can also see a general uptick for the PC market this year on Wall Street. The sector that was slaughtered last fall turned into a safe haven from the overall Nasdaq.

That confidence rests on little or no support.

PC makers have burned through their supplies, but it's the other end--demand--that matters most. And there are no signs of a return to rapid expansion for personal computers. Even Applied Materials executives admitted they don't know when demand will pick up again.

No one else can say that things will improve this year. Merrill Lynch analyst Stephen Fortuna this week again cut his forecast for PC growth in 2001.

"We are reducing our worldwide PC unit growth forecast for the current year to 3 percent from 7 percent previously," Fortuna wrote in a research note released yesterday. "All of our checks continue to suggest that PC demand remains weak, especially in the United States. We have had several negative data points since our last reduction of March 26 that have led to this unit growth revision."

Merrill Lynch did raise its 2002 industry growth projection to 17.5 percent from 15.5 percent, which looks strong compared to this year. But it remains lower than the PC sector's glory days.

Many of Fortuna's peers remain skeptical about buying PC stocks. J.P. Morgan H&Q analyst Walter Winnitzki stuck to a "market performer" rating on Dell, even though that stock has actually fallen in the past month.

"The near-term trading range for the shares is likely to extend downward given what is likely a permanent change in the company's profitability and the shares valuation," Winnitzki wrote. "On a realistic earnings per share for next year, the shares carry a price-to-earnings ratio of about 1.9 times our secular growth rate of about 15 percent, which is still somewhat pricey in our opinion."

The PC market is maturing, and adulthood is always permanent. But judging by PC stocks, Wall Street this year has been hoping for a youth potion. 22GO>