Okay, this is a revisit but because we are in the throes of earnings season some of these thoughts are worth repeating. This particular note was sent in early March and got passed around quite a bit. Eric Savitz called it a "Magnum Opus".
Opened yesterday morning's e-mail with stories from Institutional Investor Magazine and what do you know? Right up front there's an article where JP Morgan semiconductor analyst Chris Danely serves up ten rules for investing in technology/semiconductor stocks: http://www.iimagazine.com/Article.aspx?ArticleID=2117316&LS=EMS251261
Boy, talk about great fodder.
After discussing this list with several investment friends I thought it would be fun to pitch in a few comments along with a few more insights. As you read this please note that the Top Ten Rules from the article are italicized. My comments are in bold letters. Just so you know, no holds were barred in the production of this message.
And here we go:
1. Don’t ever Buy or Sell a tech stock based on valuation. Tech stocks are still largely momentum investments. They go up if the estimates are going to go higher and go down if the estimates are going lower and seem "cheap" prior to a blow up, and "expensive" prior to a run up.
---- Technology stocks, when they fall from favor, trade on valuation. Sadly those valuations tend to be very, very low. With the demise of the hedge funds the above strategy may be mitigated.
2. Exchanging higher revenue growth for lower margins never works. The reason many tech companies have such high multiples is the high margins and high cash flow they generate. When margins go down, multiples go down, ergo, stock goes down.
--- To reiterate; It never works. For most companies lower margins are inevitable as the industry matures.
3. Lead times going out is good. Lead times coming in is bad. These are two occurrences tech companies will deny, deny, and deny ’til the cows come home. They will insist that there is no double ordering when lead times stretch out, even though their customers will openly admit it. They will also try to say their customers will not cancel orders when lead times come in.
--- Agreed, although some interesting balance-of-power issues have surfaced as the food chain has required the semiconductor vendors to hold more inventory.
4. Very rarely is "it’s different this time" a good rationale for investing in tech stocks. I can’t count how many times I’ve heard: "Inventory is better managed" or "Our biggest customer just blew up, but we’re fine." In over a decade of covering tech stocks, VERY RARELY is it different this time. The reason? Human nature is difficult to change.
--- Except it is really different when the world goes into a credit crunch.
5. Technology company management is ALWAYS bullish. Tech company managements are often founders; they work very hard, and have a huge amount of skin in the game. The company is their "baby." Case in point, my mom still loves me after I put her through hell and beyond for the first 25 years of my life.
--- Yes, pathologically so.
6. "Looking through a tough quarter or two" never works. When a tech company blows up, the negative estimate revisions are usually much greater than anticipated.
--- Looking through a tough quarter or two refers to the hopes of the analyst with a buy on a stock that is sinking. It also shines a spotlight on the diminishing propects of a bonus in quarter or two.
7. Intel stock usually follows its gross margins. I have charted this axiom of semi investing back almost 20 years, and it still works.
--- Why? Because with huge capital intensity, small changes in revenues and profits are amplified due to the fixed costs of depreciation and amortization. (Tick-Tock)
8. When a technology company says, "Our revenue growth will come from the Medical or Healthcare end markets," what they’re really trying to say is, "We have no revenue growth." While electronic content is increasing in both applications, the number of units are tiny compared to cell phones or PCs.
--- Yes. The only exception is if they mean they are selling drugs.
9. It's never "just a one-quarter problem." When a tech company blows up sometimes you hear, "its just a one-quarter problem. Business will be back to normal soon." Technology stock corrections are at least two, if not three quarters of sequential declines, even worse when share loss is involved.
--- The one quarter problem is more usually spoken by the analysts and not company management. See #6 as to why.
10. If a tech company either has or supplies into a hot-selling product, consensus estimates are usually way too low. Product cycles never cease to amaze me at how strong they are and how many people will buy the truly revolutionary products such as iPods, cell phones, BlackBerrys and digital TVs.
--- Yes, sort of. Estimates are often too low but beware of customer concentration. When that product comes off its growth trajectory, or the client finds a lesser cost supplier, you will find you need a corollary to further define that ditty.
And just for kicks, here are a few more that could be added to a technology investors toolbox:
11. For an analyst it is normal and expected to be, "Seldom right but never in doubt."
12. When in doubt about issuing a recommendation err on the side of a buy. This is the sell-side credo of professional longevity.
13. In a cyclical industry, it is difficult to be faulted by positing, "It’s never too early to buy."
14. Management can give accurate guidance in an up cycle because the selling funnel is a good leading indicator and production can be efficiently planned for.
15. Management is lousy with guidance in a down cycle; salespersons are optimistic by nature and thus move from excellent to poor indicators without notice. Management, driven by stock options, are loathe to admit a downturn and slow to take corrective action.
16. Management, as a matter of policy, will let the Street tell them it’s a downturn.
17. Charges and write-offs do wonders for future earnings.
18. Stocks seldom recover from the $5/share line-of-death. Those that do make for very rich returns. Gamblers’ dilemma.
19. Watch asset management metrics like inventory, receivables and payables. They give good clues to the ability of management.
20. Few companies can grow at rates above 10% or 15% for very long.
21. Compare cash generation with earnings. Disparities are telltales.
22. Competitors will give you more information about the soft-under belly of subject company than company management.
23. Most analysts have some value, and no analyst has it right all the time. Think, reason, and extract value from those selective strengths.
24. Inside information is illegal. It is also an excellent source.
25. Talk to customers and customers’ customers.
26. Ask the analyst how they derived their estimates. What drives revenues and margins? How does the company outperform GDP?
27. Ask the analyst what they know that the Street doesn’t.
28. Technology M&A is rife with problems. It is almost always bad for the predator and good for the prey.
29. Know what the M&A motivations are. Expanding into new markets can foretell that management is concerned about current market.
30. Technology companies that are doing extraordinarily well are subject to rapid turns in performance. Do not become complacent.
31. The business is about relationships. Smart, informed people are good sources no matter where they are. These people can be surprisingly helpful long after they leave a researched company. And even if they are no longer connected, friends are good for the soul.
I could go on.....
Lucky for you I have to go tap some Maple trees!
P.S. A hybrid of this list was published over on the Barron's Tech Trader Daily blog. Here are the links: