Computer stocks' surge no fluke

Strong earnings and not market overvaluation are responsible for computer stocks' out-of-season growth, analysts say.

4 min read
Six weeks of booming growth have helped computer companies overcome seasonal depression.

The second quarter is historically the roughest of the year for computer makers, and when first-quarter results were released, many companies issued warnings that the second quarter would be flat or slightly off. But surprising profits have fueled strong growth in the sector: Stocks have jumped about 30 percent on average since July 1.

The biggest gainers include Compaq (CPQ), which has jumped 38 percent to 65, Dell Computer (DELL) has jumped 33 percent to 87-7/8, and Silicon Graphics (SGI) has jumped 44 percent to 27-1/16.

Analysts say the growth is not without merit and investors should not be worried about computer securities being overvalued; price to earnings ratios have remained stable. In fact, they say waiting to get in on big stock growth may be a mistake as companies move into the stronger half of the year.

"The industry is remaining strong. For someone with a long-term time horizon, now is just as good a time as any," said Jeff Baker, an analyst with Principal Financial Securities.

"If you are worried about paying too much at an all-time high, take advantage of daily pullbacks," Baker said. "But if you wait, chances are that stocks will still be at 52-week highs."

Explaining the second quarter's traditional anemia, Baker said "The fourth quarter has the holidays pushing growth; European spending fuels Q1 as their fiscal year ends in March, so many companies are using up their budgets; Q3 is fueled by corporate spending; but the second quarter is slow because a lot of people are on vacation and there is nothing to push demand."

And while the computer sector as a whole has been experiencing some slowdown, there is no immediate reason to be concerned, Baker said.

The market slowed to the 20 percent range for past the five years, and is now growing at rates in the upper teens, "but there aren't too many industries that are growing at that rate," said Baker.

The consumer market has not been strong--part of the reason for slowing growth--but sub-$1,000 personal computers could reverse that trend. It opened another 20 percent of the population in the United States as potential first-computer buyers, and it is also an opportunity for some households to purchase an additional computer, Baker said.

Companies that focus on the consumer market, such as Gateway 2000 (GTW), have managed growth even amid slower consumer spending by broadening their product offerings. Earlier this month, for example, Gateway said it will deliver a series of NT workstations based on the Intel (INTC) Pentium II processor by the end of this year.

On the flip side, corporate spending has been strong with companies making the transition from Windows 3.1 to NT and upgrading systems as processing speeds increased. Baker expects that growth will continue to be strong because no one company owns a majority of the worldwide market, and "the opportunity to expand is huge."

The larger companies will be the winners as the industry consolidates. They can afford to continue investing in the worldwide market and can take advantage of falling component prices by lowering prices to consumers. Smaller PC manufacturers cannot afford to operate with strong pricing pressures. "Dell and Compaq will pick up the business," said Baker.

He expects Dell's sustainable growth for the next three to five years to be around 30 to 35 percent, and Compaq's growth to be about 25 percent.

For investors concerned about the economy's impact on stocks, the best companies to purchase are the ones that can weather any type of pressure. Here again, the big companies--Dell, Compaq, IBM--tend to be the first ones to come back if there is a market correction, Baker said. "Smaller companies don't jump back as fast."

The computer maker with the largest gain since July 1 was Apple Computer, which has enjoyed a 48 percent jump in valuation. However, because Apple's stock reacted to the news of its new board of directors, rather than to its second-quarter jump in revenue and earnings, it didn't follow the movement of the sector as a whole.

Although Apple did report a smaller-than-expected loss for the second quarter, its stock started to trail off after the earnings announcement, until rumors of Jobs joining the board of directors gave it a push.

Computer stocks rise with
the summer heat
Apple Computer
13.1875 24.625 46%
Compaq Computer
40.75 65 37%
Digital Equipment
35.5 46.875 24%
Gateway 2000
31.5 40.375 22%
54.875 65 16%
Dell Computer
57.1875 87.875 35%
91.875 108 15%
Silicon Graphics
15.0625 27.0625 44%
Sun Microsystems
36.625 53.375 31%
Tandem Computer
21.375 33.875 37%
Micron Electronics
17.5 17.0313 -3%
Source: Data Broadcasting Corp.