Teachers pet! Teachers pet!
That was the chant of my junior high friends when my homeroom teacher, Mr. Ellis, sent me to the school office to copy materials on the mimeograph machine.
In all fairness, though, I dont really think I was his favorite. I just happened to know how to run the mimeograph machine better than anybody else in my class.
You remember mimeograph machines, dont you?
Youd peck out a master copy on a typewriter, using a black, waxy stencil and wrap it around a rotating drum. A hand-crank pressure roller would force ink through the stencil and on to plain paper. The process was invariably cheap. But it was also messy as all heck, and I always managed to coat my hands in black ink.
The two mimeo greats, A.B. Dick and Gestetner Cyclosytle, enjoyed decades of booming business and handsome profits. They were among the high-tech giants of their time.
What happened to them?
They ended up in the same tech graveyard as Smith-Corona, Commodore, and thousands of other whiz-bang, cant-miss, super-duper gismo companies.
Look Whos Got Messy Ink
All Over Their Hands Now!
Im talking about Intel, the company Ive been warning you about for months. The computer business is changing rapidly, and the fourth quarter report from Intel was covered with mimeograph-like smudge marks.
Smudge Mark #1: Weak sales. Fourth quarter sales were a huge disappointment to Wall Street well below both analyst expectations and Intels previous forecasts.
Intel pulled in $10.2 billion of sales last quarter, $300 million below the $10.56 billion that the Jack-and-the-Beanstalk crowd was expecting … and even below the $10.4 – $10.6 billion Intel had assured Wall Street it would make in its December 8 mid-quarter update.
Business is clearly slowing down, and its doing so even faster than cautious Intel insiders were saying.
Smudge Mark #2: Falling prices. Money and Markets readers know that Intel’s chief rival, AMD, has been circling the wagons for a long time, sharply undercutting Intels prices. Now, Intel CFO Andy Bryant has summed it up by admitting that competition is pretty fierce out there right now. Ergo, the lower than expected desktop processor unit shipments and prices.
Whats the problem? Precisely the same one Ive pointed out to you many times: Not only has AMD built a better (faster) mousetrap, it is also selling that mousetrap for less than Intel.
Now that the price of PCs has fallen to the $400 to $500 range, Intel chips are just too darn expensive, which is why Bryant finally admitted AMD may be taking market share away from Intel.
Smudge Mark #3: Falling profit margins. Fourth quarter profit margins were equally disappointing. Intel reported a 61.8% profit margin versus the 63% expectation. Worse, Intel warned that profit margins would fall to 57% in 2006.
Shrinking profit margins are symptomatic of a maturing if not declining industry.
The big picture: Personal computers are simply not the futuristic piece of Buck Rogers technology they used to be. Like microwave ovens, televisions, and calculators, theyve been transformed into cheap commodities, with profits reduced to a small fraction of what they used to be.
Smudge Mark #4: Sinking demand. The root of Intels problem is that demand for its bread-and-butter PC microprocessors is simply flattening out.
The evidence: Intel admitted that sales in North America dropped by 3.5% in the last 90 days because of lower-than-expected demand for desktop processors. And for the entire year, desktop chip sales dropped by 6.2%!
Smudge Mark #5: Balance sheet balloons. Two hard-and-fast financial facts caught my attention:
1. Inventory has ballooned from $2.62 billion 12 months ago to $3.12 billion today. Think about that. Were talking about $500 million of extra inventory that didnt exist one year ago.
2. Accounts receivables are also growing like a weed. Twelve months ago, Intel was carrying $2.99 billion of receivables. Today, that number has ballooned to $3.91 billion.
Let me tell you: Whenever you see a company report a big surge in both inventory and accounts receivables … then youre probably looking at a shrinking business.
Smudge Mark #6: Options expense looming. Intel is one of the few holdouts that have yet to expense stock options when calculating profits. That means Intels disappointing results could be even worse than Wall Street thinks they are.
And by they way, Intel also announced that it would no longer give mid-quarter updates. Seen enough bad signs? Wait. Theres more …
Smudge Mark #7: 2006 looks even worse. Intel also delivered a worse-than-expected first quarter sales forecast of $9.1 billion to $9.7 billion. The Wall Street crowd was counting on $10 billion of sales.
End result: Intels shares plunged last week … and theyre continuing to fall right now, plunging through the lows of last October, last April and, now, even last January.
And were not talking about a fledgling upstart or a deadbeat has-been (at least not yet).
Were still talking about the biggest semiconductor maker in the world, a bellwether for the entire sector. Heck, just yesterday, the decline in Intel’s shares (on top of last week’s plunge) was the biggest single drag on the Dow!
Did IBMs Results Really Shine? Or …
Were They Holier Than Swiss Cheese?
While Intel were mourning last week, IBM investors were celebrating.
IBM Steady Amid the Storm, said one headline.
Big Blue is in the Pink, said another.
All Wall Street saw was a company that increased its profits from $4.38 a share in Q4 of 2004 to $4.87 in Q4 of 2005.
But thats not what I saw. I didnt need a microscope to see a news release filled with more holes than a block of Swiss cheese. Here are just the main ones:
Hole #1: Falling sales. IBMs revenues fall from $96.29 billion in 2004 to $91.13 billion in 2005 a 5.4% decline. The hear-no-evil crowd tried to explain away the drop by noting IBMs sale of its PC division to Lenovo.
But even if you add back in the old PC revenues, the total would still be down by 1% in the fourth quarter. And look at these numbers:
- Service revenues off 4.9%,
- Hardware revenues down 27.4% (including its divested PC business in year-ago figures)
- Software revenues up a meager 0.3%
- Financing revenues down 8%
The biggest red flag of all: IBMs admission that its consulting unit, which accounts for more than 50% of the companys income, suffered a 6% drop in Q4 sales, falling from $12.7 billion in 2004 to $11.5 billion in 2005.
Hole #2: Merging your way to prosperity doesnt cut it. IBM is trying to buy its way out of trouble.
See that 0.3% growth in software sales? Well, thats despite the fact that IBM made 16 acquisitions in the last year. Pathetic.
This is not a new problem for IBM. Going back five years, all you can see is anemic revenue growth.
Back in 2000, Big Blue had sales of $88.3 billion. Last year, it was $91 billion.
So in six years, three of which were supposed to be gangbuster boom years, IBM has barely managed to grow its top line, increasing it by a lousy $1.8 billion dollars.
Thats a meager 2.1% in more than a half decade. And IBM continues to be a Wall Street darling?! Somethings wrong with this picture.
Hole #3: Buyback hanky panky. IBM is keeping Wall Street happy and fooled by delivering more profits per share.
But it makes you wonder: How has IBM done this in the face of virtually flat sales growth? Part of it was due to actual earnings growth.
But another factor has been buybacks of company stock. IBM ended 2005 with 1.57 billion shares outstanding versus 1.63 billion shares at the end of 2004. If you back out those buybacks and use a comparable measurement of earnings per share, IBM’s fourth-quarter earnings would have been $1.88 a share not $1.99 a share.
Hole #4: Disappearing cash. Just in the last quarter, in order to buy back all those shares, IBM spent $1 billion of shareholder cash. That helps explain why IBMs cash shrunk by $396 million in the last 90 days. And over the last 12 months, cash shrunk by a full $1 billion.
And I repeat: This is not just a story about a few select companies. If IBMs business is sluggish, its a sign that (a) corporate IT spending isnt what Wall Street thinks … and (b) the Wall Street crowd is still blind to the handwriting on the wall.
Is Business Booming at
Freescale Semiconductor?
Not Quite!
The shares in Freescale Semiconductor, a maker of communication chips, soared by 41% last year. So youd think business must be booming at Freescale.
Not true.
Even though Freescale reported better-than-expected Q4 profits last week 45 cents instead of 38 cents business is not so hot.
I say that because Freescale has the same problem as IBM: a very stagnant business.
In 2005, Freescale sold $5.84 billion worth of chips. That may sound like a lot of chips but not when you consider that Freescale pulled in $5.72 billion of sales in 2004, only 0.2% less.
Call me old fashioned, but a lousy 0.2% increase in sales doesnt impress me.
Chickens Coming
Home to Roost
This is not the first time youve heard me raise serious doubts about the so-called Wall Street wisdom, especially in the tech world. They live in their world. I live in mine, and mine, I feel, is a lot closer to the high-tech reality that actually drives this industry.
Now, though, it looks like some of the chickens are coming home, and the nest-eggs of investors still in love with so-called technology leaders, already decimated in years past, may be in for another beating.
Fridays 213-point plunge in the Dow Jones may have gotten most of the headlines. But I believe an even bigger siren was sounded by the Nasdaq, which lost 54 points.
Nothing to worry about! say the hear-no-evil fans of Intel, IBM, and Freescale. Business is booming! they insist. Profits are soaring!
In other times, maybe. But not now. Now, youve got BOTH
(a) many big smudges, holes and cracks in the business of the tech leaders plus …
(b) the first big crack in their shares.
These are two dots that connect very neatly. I doubt theyre just a passing phenomenon.
To me, theyre a clear warning sign that its about time you change the way you invest in technology stocks.
My Recommendations
First, if, despite our warnings, you still own stocks like Intel and IBM, then dont wait around any longer. Sell immediately. Even though theyre already down, theyre going down a lot lower. If youre really in love with the companies, think about buying them back then.
Second, if youre still investing in the top tech stocks of the 1990s, the odds are high that your portfolio is full of companies like A.B. Dick and Gestetner. Weed them out, too.
Third, think outside the box. Find the true innovators. Then time your investments to avoid the crowds. If you do, the opportunities can be greater than ever, especially in Asia.
Fourth, there is a way to capitalize on the kind of situation were seeing in Intel-AMD: I run an options service called Stock Market Dogs.
And in this service, Ive been recommending put options on Intel (which are soaring in value as Intel falls) … and … at the same time, call options on AMD (which are soaring in value as AMD surges).
Right now, Im looking for the right time to tell them to take profits. So its a bit late to jump into those options now. But puts and calls, used wisely and with money you can afford to risk, are great vehicles for taking advantage of the schizophrenic market weve been telling you about.
You just buy puts on the stocks you think are vulnerable to a dump.
And you buy calls on the stocks you think are likely to enjoy a surge.
Losses are entirely possible. But so are big profits. And the most you can lose is the amount you invest, plus any commissions you pay your broker.
Fifth, make sure you have a solid allocation to non-tech sectors especially the energy stocks Sean is recommending in his natural resource service.
After a spectacular performance last week, you’d think energy stocks would be due for a rest, right? Heck no! They were up sharply AGAIN yesterday!
Best wishes,
Tony
About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
2006 by Weiss Research, Inc. All rights reserved.
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