Investing in Hardware Stocks

Copyright 2005 by Morris Rosenthal -All Rights Reserved contact info

Losing Money

Trading Notes

Trading the Computer Hardware and Component Manufacturers

The computer hardware sector has been a great place to lose money over the last five years or so. The strongest performer over time has been Dell, which continues to take market share away from all comers, even as they try to consolidate (HP, Compaq, Digital, etc) themselves into a leadership position. However, even the mighty DELL has yet to return to its multiple peaks during the bubble, despite consistently beating earnings and revenue projections quarter after quarter. With a P/E of 34 DELL is the only big cap (100 billion) computer hardware company that's still seen as a growth stock.

At the opposite end of the spectrum from Dell is Hewlett Packard, HPQ. After a somewhat pointless merger with Compaq, HPQ has struggled to find a new direction, experimenting with all-in-one consumer entertainment offerings, a market that will probably belong to Apple, Sony or Dell in the end. New management may help HP concentrate on the core business of printers and servers, although their low cost PC offerings actually boosted the bottom line last quarter. HPQ has a moderate P/E (for tech stocks) of 18, pays a 1.5% dividend and still retains a market cap of almost 70 billion dollars.

Powering all of the Dells and most of the HPs are Intel processors. Intel wasted quite a bit of time and opportunity trying to transform themselves into a "network" company, but they seem to be waking up to the fact that their franchise is the CPU and everything else is just window dressing. INTC has suffered from product delays and recalls in recent years, but it hasn't really affected their dominant position in the CPU market, which remains an incredible cash cow. Intel stock is trading at around a quarter of it's bubble valuation. The company's market cap (briefly the richest in the world) is around 150 billion and the P/E is just over 20, with a dividend yield a little over 1%. Intel has far and away the largest trading volume of our hardware stocks, at 70 million shares a day, and a high concentration of retail investors, similar to Microsoft.

Advanced Micro Devices is remains the only challenge to Intel's sovereignty, though I don't think they've ever manage to achieve even 20% of Intel's market share. The stock is very volatile with news reports, it's trading volume is similar to Dell's, despite the market cap being only 6% of Dell's at just over 6 billion. AMD's current P/E is 68, but this goes up and down violently with new product releases and price wars with Intel in both the CPU and Flash Memory markets. Despite the volatility, AMD has the second highest institutional ownership of our group at just under 80%.

A company that's traditionally similar to AMD in terms of market cap, volume and volatility is Micron. MU is the red, white and blue play for the memory market, and they are currently trading at just over 10% of their peak bubble value. Memory, unfortunately for MU, is is the most commoditized computer component, with the Koreans and Japanese controlling the market. Because of the volatility, MU holds onto a P/E of 25 with a market cap of 7 billion and just over 80% of her shares are held by institutional investors.

A stock that plays well in both the PC and video game hardware markets is the graphics chip maker, Nvidia. NVDA is another one of those stocks with a high interest level amongst retail investors who buy their products and figure they can't lose. With a P/E of nearly 65 and stiff competition from ATI, NVDA counts on a fragile technological and marketing edge to maintain a huge P/E lead over it's rival.

ATI Technologies is the mirror image of NVDA in just about everything except finding favor with investors. ATYT (the American shares of this Canadian company) trades at a P/E just over 20, though at this level their market cap falls just short of NVDA. ATYT trading volume also falls well short of NVDA shares, around 50%. Delving into what justifies the valuation difference between these two companies will be one of the first stops for our coming in depth analysis.

Western Digital is the pure play hard drive maker, and is also the first individual stock I ever purchased online. They make a great product, but it's an incredibly competitive commodity market with at least five major players, and it seems the only way to maintain margins is to move manufacturing from one low cost country to the next with each new factory. WDC trades at the lowest P/E in our group, just under 15 times earnings, which reflects what professional investors think about their growth potential. Market cap is just over 2 billion, and daily trading volume around 2 million. Institutional investors hold around 70% of the shares, which I'd call neutral for this sector.

Rounding out our category is a small cap peripheral storage manufacturer, Iomega. IOM has been in and out of my portfolio so many times that I can't even estimate how much I lost on them. They have a history of innovative and unique products that develop a niche clientele, but only on a small scale. It's also the first stock I owned to do a reverse split, 5 for 1. IOM shares trade at less than 5% of their peak value in the mid 90's, when it looked like their Zip products were poised to take over the storage world. The Internet pretty much killed that fantasy. The current P/E is infinity, i.e., negative earnings, and the daily handle is around 200,000 shares.


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