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Turnaround in tech
Analysts now expect a late-year boost that could help Applied Materials, IBM, Intel and Microsoft.
October 11, 2005: 8:37 AM EDT
By Michael Sivy, CNN/Money contributing columnist
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NEW YORK (CNN/Money) - Over the past month, analysts have become increasingly optimistic about a potential turnaround in the tech sector.

Likely beneficiaries would include industry leaders, such as Applied Materials, IBM, Intel and Microsoft. All four stocks have been relatively depressed and are currently trading at least 15 percent below their highs from January 2004.

Although semiconductor sales growth has been flattish, industry forecasters see signs of the beginning of an upswing that could run for several years. Barring an unexpected recession, growth in chip sales could rise from 4 percent this year to 6 percent in 2006 -- and peak at 8 percent or so by 2008.

The semiconductor-equipment industry is also seeing an uptick in demand. The key book-to-bill ratio has been above 1.0 for two months in a row. Basically, that means that new orders are coming in at a faster rate than old orders are being completed.

In addition, some analysts anticipate increases in corporate spending on technology and a pickup in merger and acquisitions activity in the sector.

Since most tech businesses are already dominated by two or three giant companies, mergers are more likely to be across product lines and acquisitions are likely to be large companies scooping up small ones or small companies banding together.

The upshot would likely be higher top-line growth for a slightly leaner industry, with companies that are more efficient and more diversified. Those trends should boost profit margins.

Such an environment would be bullish for the largest and financially strongest stocks that dominate the important sub-sectors of the tech group.

Applied Materials is waiting to see if chip demand remains strong beyond the holiday season. Utilization rates for chipmakers are currently above the level that encourages them to buy new semiconductor equipment. If that lasts until January, Applied Materials could see a rise in orders that would substantially increase profit margins. Earnings are projected to grow at a 15 percent compound annual rate over the next five years. At $16.85 a share, the stock trades at about 20 times earnings for 2006.

IBM is enjoying strength in its computer-services division and is gaining market share in mid-range and top-end computer servers. Both trends reflect improving corporate IT spending. Growth is projected at 11 percent annually over the next five years, and the stock pays a 1 percent dividend. At $81.25, the shares are trading at 14.9 times estimated 2006 earnings.

Intel would be an obvious beneficiary of rising sales of computer chips. But the company has a more important plus. Intel is introducing new microprocessors that should give the company's earnings a boost over the coming year or two. Consensus estimates are for 15 percent compound annual growth over the next five years. At $23.42 a share, the stock trades at 14.6 times next year's earnings.

Microsoft also stands to benefit from a general revival in tech stocks. But the shares may be more appealing to value investors. Entertainment and server software remain growth areas. But the stock's greatest attraction may well be that it has no debt and more than $37 billion in cash on hand. Microsoft's growth rate is projected at more than 11 percent a year, and the shares pay a 1.3 percent yield. At $24.46 a share, or 16.3 times next year's earnings, the stock looks quite appealing for long-term investors.

Sivy on Stocks resources:

Sivy 70: America's best stocks

Guide to Growth

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Michael Sivy is an editor-at-large for MONEY magazine. Click here to receive Sivy on Stocks via e-mail every Tuesday.  Top of page

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