PCs in '05: Tough Act to Follow

The PC industry was good to investors in 2004, despite a slow start. Dell(DELL Quote) and even troubled Gateway(GTW Quote) sported advances on Wall Street of 25% and 41%, respectively, while a reinvigorated Apple Computer(AAPL Quote) appreciated by an astonishing 212% by mid-December.

All three of the sector's publicly traded pure plays were helped by a second-half rally that floated a lot of technology boats, and by strong sales of PCs as well. Market researcher IDC estimates that worldwide sales of desktop PCs, notebooks and low-end servers will have increased by 14.5% by the time the ball dropped in Times Square.

Apple's 2004 Shine iPod mania sparked a massive surge

Apple, of course, is becoming less of a computer company every minute -- and is therefore less vulnerable to the ups and downs of the PC market. In its fourth quarter, for example, sales of Apple's hit iPod music player and related services such as iTunes accounted for 27% of the company's total revenue. In the December quarter, when consumer-electronics items top holiday shopping lists, the iPod will contribute 32% of the company's revenue and about 26% of gross profit, estimates Goldman Sachs analyst David Bailey.

The coming year is not likely to be a replay of 2004, but that's not to say it won't be interesting.

The growth in PC sales is expected to slow to 10.1% in 2005, said IDC analyst Roger Kay.

But with IBM(IBM Quote) out of the PC business, many analysts believe Dell and Hewlett-Packard(HPQ Quote) are likely to pick up market share while customers wait to see what Lenovo Group, the new owner of Big Blue's long-suffering segment, has in mind.

Apple will likely roll over rivals that are hoping to grab a share of the online music business, but forecasting significant appreciation for its already expensive stock is a challenge.

Charlie Wolf, of Needham, one of three sell-side analysts who downgraded Apple in early December, said in a note to clients: "The stock has had a spectacular run in 2004, chiefly on the strength of exploding iPod sales. In our opinion, the upside the iPod might deliver going forward is now captured in the company's share price."

Even Ryan Jacob, the generally bullish manager of the Jacob Internet Fund, has pared his position in the stock way down, and said that looking for upside "is a very tough call. The wild card is how well will iPod sales translate into computer sales."

Making a Move to Mac

Ryan and other analysts say that some iPod buyers are so happy with their purchase that they've switched from Windows-based computers to Macs. Within the industry, that trend is called "the halo effect."

Citing the cost and difficulty of switching platforms, Wolf figures that few Windows users will jump to Macs, but "Apple's leadership in software applications that manage digital content could translate into a much higher switching rate than we're forecasting and, in turn, a much higher valuation." Wolf downgraded Apple from buy to hold. (His company has an investment banking relationship with Apple.)