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Technology Report Weekly Roundup

BY Richard Suttmeier | 08/19/05 - 05:16 PM EDT
Stocks in Focus: CSCO, GTW, IDTI, JNPR, MSFT, NEWP, OTEX, QLGC, RSAS, SUNW, TWX, VRSN, XLNX

The rally in tech stocks has wilted in the dog days of August, but despite this pullback my models suggest that a rotation into technology remains a compelling longer-term investment strategy for both fundamental and technical reasons. Technology remains the most undervalued sector, according to my models, and the monthly chart profile for the Nasdaq will keep its positive profile, even on weakness to 2060.

Since setting a new four-year high of 2219 on Aug. 3, the Nasdaq has made an orderly pullback, dipping some 3.9% to its low of 2133 on Thursday, Aug. 18, which was my value level (a price at which my models project that buyers will emerge) for this week. Even with this modest correction, the Nasdaq is up 12.9% from its April 29 low of 1890 to the Aug. 18 low of 2133.

In part, the decline has been driven by investor concerns about higher U.S. Treasury yields, which have stabilized since the Federal Open Market Committee raised the federal funds rate to 3.5% on Aug. 9, and higher crude oil prices, which may have peaked with the Aug. 12 high of $67.10. Plus, this week's economic data notched up investor concerns another degree. The producer price index (PPI) for July rose an unexpectedly strong 1%, vs. expectations for a 0.6% increase. Excluding food and energy, the gain was 0.4%, vs. expectations of 0.1%. Inflationary pressures should keep the FOMC in a rate-raising mode, and this could potentially fuel an exit from stocks. The coming week's key economic data include existing- and new-home sales and durable goods orders, and in recent months these data have shown that the economy is on a solid footing.

Another downer for the Nasdaq came from negative market reaction to Cisco's (CSCO:Nasdaq) and Dell's (DELL:Nasdaq) earnings releases last week. However, the index stabilized midweek with positive reactions to Applied Materials' (AMAT:Nasdaq) and Hewlett-Packard's (HPQ:NYSE) earnings Tuesday evening. In addition, so far the Nasdaq pullback has not dampened its weekly chart profile. A weekly close below the five-week modified moving average at 2133 would have signaled a pullback of 7.2% to my monthly value level at 2060. If this correction ends, my models show that the upside potential to the end of September is my quarterly risky level at 2381. (A risky level is a price at which investors are likely to reduce holdings, according to my model.)

But even with a deeper correction, tech stocks are still the place to be. My fundamental model shows that technology is now 14.4% undervalued, with health care the only other undervalued sector at 4.2%. All other sectors are overvalued, with energy 9.7% overvalued after getting the most investor attention for much of 2005.

Within the technology sector, I focus on computer manufacturers, which are 28.5% undervalued vs. 27.2% last week; semiconductors at 21.4% undervalued vs. 20.2% last week; and software at 17.3% undervalued vs. 15.6% last week.

The benchmark Technology SPDR (XLK:Amex) ended the week down 0.14%, while the S&P 500 was down 0.87%. Since its inception April 4, the model portfolio is up 5.23% (including cash) vs. a gain of 7.29% for the XLK and 400% for the S&P 500.

The model portfolio's gain since its inception on the dollars invested is 6.12%. Closed positions are up 12.23%. To review my portfolio strategy, I am focusing on big-cap technology leaders, turnaround stories and emerging technologies within my focus industries -- computer manufacturers, semiconductors and software.

Portfolio changes this week include booking a 9% profit on one part of the QLogic (QLGC:Nasdaq) position, and doubling the Gateway (GTW:NYSE) holding on weakness. Presently, the model portfolio has 21 positions -- 19 longs and two shorts. To keep the number of positions manageable, once the number of positions reaches 25, I will close an older position whenever I find a better long or short candidate.

Now let's recap all of the portfolio holdings. A quick reminder on the rating system: Ones are stocks that are buys right now. Twos are stocks that are buys on a pullback in price. Threes are stocks that are sells on strength in price. Fours are stocks that should be sold right now.

Long Positions

ONES

Cisco (CSCO:Nasdaq, $17.82, 600 shares, 8.06% of the portfolio): This position consists of three lots -- 225 shares added at $17.66 on April 4, 175 shares at $19.25 on June 14, and 200 shares at $19.19 on June 27 -- for an average cost basis of $18.63. Cisco is 38.4% undervalued, and I am reducing my price target to my quarterly risky level at $21.30, which I expect shares to reach over the next six months.

My thesis of increasing demand for broadband around the globe keeps Cisco in a desirable spot as the leading provider of products and services that are needed to modernize Internet protocol. Cisco is focusing on technologies such as voice-over-IP, security and wireless, and success in this strategy appears likely in my judgment. CEO John Chambers indicated in the recent earnings conference call that the company is achieving the No. 1 position in most of its advanced technologies, and is gaining market share on top of that. Cisco is experiencing well-balanced growth across all geographies, consumer markets and product segments.

Gateway (GTW:NYSE, $3.17, 2,400 shares, 5.74%): I added 1,200 shares of Gateway on July 6 at $3.42 a share, and another 1,200 shares at $3.18 on Aug. 16, for an average cost basis of $3.30. The stock is 71.70% undervalued, and my price target is my quarterly risky level at $5.59, which I expect to be achieved over the next six months.

Although Gateway shares declined 22.6% on the negative reaction to earnings from Monday's close of $3.89 to Tuesday's low of $3.01, the model portfolio's full position is down only 3.94%. Shares fell to my monthly and quarterly value levels at $3.14 and $3.07, respectively, making shares more than 70% undervalued and leading me to double this position. Gateway remains one of my technology turnaround stories: It is expanding its channels for product distribution in Japan and in Staples stores in the U.S., and the company is gaining larger information technology deals for personal computers and related equipment from organizations such as the U.S. Navy and the University of Texas at San Antonio.

Integrated Device Technology (IDTI:Nasdaq, $10.60, 375 shares, 3.00%): I added 375 shares of IDT to the portfolio at $10.42 on July 11. The shares are 49.3% undervalued, and my price target is the stock's 52-week high at $21.25, which I expect it to reach over the next six months.

IDT designs chips and chip sets that are used in various processes in networking and communications, and the company should benefit from the increase in information technology spending expected over the next six months. Cisco is one of its largest customers. This week, Integrated Circuit Systems (ICST:Nasdaq) said that its shareholder vote on IDT's proposed $1.7 billion cash and stock acquisition offer will be Sept. 15. I believe this deal makes sense as IDT hardware and software products for network equipment meld well with ICS products, such as those for digital multimedia.

Juniper Networks (JNPR:Nasdaq, $23.32, 175 shares, 3.08%): I added 175 shares of Juniper to the portfolio at $23.70 on July 25, and my model shows Juniper 52.1% undervalued. My price target is my quarterly risky level at $33.37, which I expect the shares to reach over the next six months.

Like Cisco, Juniper will benefit from the overall increase in demand expected to modernize the expanded use of broadband. Given the dramatic increased demand, there is room for both companies to resume a solid revenue growth path. For example, Juniper cut a deal with Speakeasy this week. The independent broadband service provider will be deploying new Juniper routing platforms in its national fiber-optic network to help small and midsized businesses more easily adjust their systems as their bandwidth needs change.

Microsoft (MSFT:Nasdaq, $26.72, 150 shares, 3.02%): On June 30, I added 150 shares of Microsoft at $25.06, and the software maker is 13.4% undervalued. My price target is my semiannual risky level at $35.20, which I expect shares to reach over the next six months.

Although Microsoft is less undervalued than my other long positions, it has many new products and services that will be launched over the next six months or so, and the prospects for the company returning to a growth mode are quite exciting. When you consider adding a big-cap tech stock as a portfolio long, you can allow that company to be less undervalued given that it has tons of cash and now offers a dividend to investors.

Newport (NEWP:Nasdaq, $13.32, 600 shares, 6.03%): I added 300 shares of Newport to the portfolio at $14.17 on July 11, and another 300 shares on July 29 at $13.17, for an average cost basis of $13.67. Newport shares are 60.0% undervalued, and my price target is my monthly risky level at $15.41, which I expect the stock to reach over the next six months.

Newport develops laser-based IT components, and these specialty instruments and systems applications should regain product sales over the next six months. The company had what I believe to be a minor hiccup in sales in its second quarter, but I expect a recovery given the recent surveys calling for increased IT spending, particularly after the terrorist attacks in London and Egypt in July.

Open Text (OTEX:Nasdaq, $12.06, 325 shares, 2.96%): I added 325 shares of Open Text to the model portfolio on July 26 at $12.24. The stock is 60.0% undervalued, and my price target is my semiannual risky level at $18.34, which I expect shares to achieve by the end of 2005.

This company develops and licenses software that allows organizations to manage documents and content over internal networks and the Internet. I expect regulatory issues related to new requirements, like Sarbanes-Oxley, and heightened security concerns to lead to an upgrade cycle in this industry over the next six months or so.

QLogic (QLGC:Nasdaq, $33.46, 150 shares, 3.78%): The model portfolio's original position of 150 shares was established on May 11 at $29.39. Trades in two more lots have yielded gains of 11% and, this week, 9.2%. QLogic is 21.4% undervalued, and my price target is my quarterly risky level at $39.35, which the stock should reach over the next six months.

QLogic designs storage-networking components with an eye to security and stands to gain from increasing demand for storage that also provides security features. QLogic has recently won several "best of breed" industry awards for product excellence, which also helps to spur demand for its products, and this week the company shipped its 20,000th switch into the fast-growing blade server market. Demand in that market is coming from customers who are using fibre channel switches to make it easy to consolidate servers and storage.

RSA Security (RSAS:Nasdaq, $12.50, 325 shares, 3.06%): I added 325 shares of RSA to the portfolio at $12.21 on July 11. The company is 49.6% undervalued, and my price target is the stock's quarterly risky level at $17.44, which I expect the shares to reach over the next six months.

The trend toward increasing online security also favors RSA Security, which develops products to secure the identities of personnel using corporate networks and services. Its software provides specific applications that are important in the effort to prevent cyber-terrorism. A survey released by RSA Security this week shows that -- despite fears of fraudulent activity and identity theft -- consumers are increasing the amount of personal business they do online if their banks and online services offer authentication. The study showed that more than 82% of respondents were concerned about identity theft and online fraud. Given these security concerns, products to enhance protection against online fraud should see increased demand.

Sun Microsystems (SUNW:Nasdaq, $3.60, 3,000 shares, 8.14%): This position consists of two lots -- 1,500 shares added at $3.55 on April 21, and another 1,500 shares at $3.75 on June 2 -- for an average cost basis of $3.65. My price target is the 52-week high at $5.65, which I expect the stock to reach in the second half of 2005. Excluding its pending purchase later this year of StorageTek (STK:NYSE), which is 12.3% overvalued, Sun ended the week 42.8% undervalued.

Sun Micro is one of my technology turnaround stories, as it is adding the products and services of StorageTek to increase business in its primary target market ¿ data centers around the world. StorageTek shareholders will vote on the propsed merger Aug. 30. Additionally, Sun is making it easier for software developers to use its software by opening up its source code, which should increase demand for its services and open the door for cooperative services with other IT vendors to provide services to common customers.

Time Warner (TWX:NYSE, $18.08, 450 shares, 6.13%): This position consists of two lots -- 225 shares purchased at $17.47 on April 4, and another 225 shares at $17.16 on April 20 -- for an average cost basis of $17.32. Time Warner is 31.7% undervalued, and my price target is the stock's fair value at $25.84, which I expect it to reach within the next six months.

The turnaround of the America Online business is my major focus in choosing Time Warner as a portfolio member. Time Warner's cable TV business is doing quite well, while its other businesses have been steady. The new portal AOL.com should compete well for advertising dollars in future quarters, and efforts by investor Carl Icahn to increase shareholder value could accelerate this process, as there are other potential hedge funds and large investors that may join in. CEO Dick Parsons and Icahn met this week, and both agreed that Time Warner shares are undervalued. The billionaire investor has been advocating the breakup of Time Warner, including a full spinoff of the cable company's television properties.

VeriSign (VRSN:Nasdaq, $24.09, 150 shares, 2.72%): This 150-share position was added to the portfolio at $24.06 on July 21. The stock is 35.3% undervalued, and my price target is my quarterly risky level at $31.97, a price I expect the stock to achieve over the next six months.

This position is another play on securing the Internet. VeriSign's networking products and services help to secure transactions over network connections to the Web. This week the company announced trials of its IP connection services at three universities: University of Michigan, Northwestern University and Texas A&M. VeriSign's service allows cellular handsets to become IP devices when near a Wi-Fi signal, giving users the ability to make VoIP calls.

Xilinx (XLNX:Nasdaq, $26.96, 150 shares, 3.05%): This 150- share position was added to the portfolio at $26.52 on June 20, and the stock is 33.5% undervalued. My price target is my monthly risky level at $30.85, a price I expect the stock to achieve over the next six months.

Xilinx provides integrated circuits and semiconductors to both the general commercial manufacturers and for specific consumer products. A strong holiday season for electronics should drive demand for the company's chips. Inventories are well-contained with some shortages noted and a strong holiday season is projected, particularly if energy prices stabilize.

Zygo (ZIGO:Nasdaq, $11.25, 400 shares, 3.39%): I added 400 shares of Zygo at $10.60 on July 11. The company is 57.1% undervalued, and my price target is the stock's March high of $14.48, which I expect the stock to achieve in the second half of 2005.

Zygo, a supplier of optical metrology instruments and precision optics used in making semiconductor capital equipment, is scheduled to report fiscal 2005 fourth- quarter results of 17 cents a share after the close Thursday, Aug. 25. This past week, Applied Materials raised its guidance in its quarterly report, which could be an indication that business is picking up at Zygo. With the increased demand for chips, the companies involved with making the chip-manufacturing equipment should be the next segment to benefit.

TWOS

EMC (EMC:NYSE, $13.17, 300 shares, 2.98%): EMC, an early entry in the model portfolio that was traded for a 15% gain, rejoined the model portfolio at $13.75 on June 29. The shares are now 61.4% undervalued, and my price target is my monthly risky level at $15.15, a price I expect EMC to reach over the next six months.

EMC, the leading provider of storage systems, has recently begun to expand its business to offer a more complete array of IT products and services, including networking gear and servers. Expanding by growth into other IT areas makes sense for the leader in storage, and this week the company made two small acquisitions. The first is privately held Rainfinity, which produces software to consolidate information from multiple network storage locations; the second is Maranti Networks, which makes network storage switches.

Intel (INTC:Nasdaq, $25.65, 475 shares, 9.19%): This position consists of three lots -- 175 shares added at $23.10 on April 4, 150 shares at $26.19 on June 27, and 150 shares at $26.95 on July 20 -- for an average cost basis of $25.29. Intel is 24.5% undervalued, and my price target is my quarterly risky level at $30.98, which I expect the stock to reach in the next six months.

What can I say other than "Intel Inside"? This means to me that Intel belongs inside every long-term technology stock portfolio. The company is building plants and production facilities in the major emerging economic regions such as India and China; it will be providing chips to Apple Computer (AAPL:Nasdaq) in a year or so; and if WiMax takes off in the next year or so, Intel will benefit. (WiMax extends Wi-Fi's range from several hundred feet to around 10 miles.) One sour note in this scenario, Advanced Micro Devices' (AMD:NYSE) lawsuit against Intel, looks like just an annoyance, particularly given AMD's recent positive guidance. How can AMD complain about antitrust issues when they are maintaining -- or in some product segments, increasing -- market share?

SBC Communications (SBC:NYSE, $24.14, 170 shares, 3.09%): I added 170 shares of SBC to the portfolio at $23.70 on July 11. The company is 25.1% undervalued, and my quarterly risky level is at $29.22, which I expect the stock to reach over the next six months.

In my judgment, SBC is the best of the major telecom providers: It owns a portion of the largest wireless company, Cingular, in a partnership with BellSouth (BLS:NYSE); it will soon be the owner of what's left of AT&T (T:NYSE), its former parent; and it has several IT products to help large and small businesses manage information and their Internet needs. This week, New Jersey regulators approved the acquisition of AT&T by SBC after SBC said it would keep several AT&T facilities in the state. The companies expect to complete the transaction by late 2005 or early 2006.

Sirius Satellite Radio (SIRI:Nasdaq, $6.44, 1,000 shares, 4.86%): I added this position to the model portfolio at $4.81 on April 28. Sirius is 33.6% undervalued, and my price target is my monthly risky level at $8.04, which I expect the stock to achieve over the next six months.

Satellite radio is one of the most important emerging technologies of the past 20 years, as its growth potential in becoming a fixture in automobiles and homes is similar to the introduction of television. I also like XM Satellite Radio (XMSR:Nasdaq), but choose Sirius over XM because of Sirius' lead in content and the fact that it has been more undervalued. Another plus for Sirius is that it will be factory-installed in most 2006 model Ford vehicles.

Symantec (SYMC:Nasdaq, $21.20, 400 shares, 6.39%): I added 225 shares of Symantec at $18.31 on May 11, and another 175 shares on July 29 at $22.10, for an average cost basis of $19.97. Symantec is 29.8% undervalued, and my price target is my annual risky level at $25.53, which I expect the stock to achieve over the next six months.

The merger between Symantec and Veritas was successfully completed in July, and the integration of their software and storage products should make the combined company a leader in the Internet software and services industry. A new email security and availability product combines antivirus and antispam services from Symantec with Veritas' archiving and data backup technology. Symantec is also acquiring Sygate Technologies, a provider of compliance software solutions, to enhance its product offerings in security and compliance applications.

THREES

Nasdaq 100 Unit Trust (QQQQ:Nasdaq, $38.82, (200) shares, 5.85%): On Aug. 10, I added a short position of 200 shares of the QQQQ at $37.34. This position is a hedge just in case the Nasdaq correction deepens in the weeks ahead.

My price target to cover is my monthly value level at $36.44, which my model suggests is the risk given a correction over the next three to five weeks. I set a buy- stop at the QQQQ's recent 52-week high at $40.50.

Semiconductor HOLDRs (SMH:Amex, $36.24, (200) shares, 5.47%): I added a short position of 200 shares of SMH at $37.13 on Aug. 9. If the correction on the Nasdaq deepens, semiconductors -- which led the index during its rally -- will likely correct somewhat more than the Nasdaq. This week's high on the Philadelphia Semiconductor index (SOX), at 469.86, was well below the week's risky level at $480.43. A weekly close below the five-week modified moving average at 454.76 would signal a deeper correction in the semis, with risk to my monthly value level at 437.03.

My price target to cover this position is $34.12, which is my monthly value level. Given a market correction, my models suggest that this level will be achieved over the next three to five weeks. My buy stop is the exchange- traded fund's recent 52-week high at $38.50.

Regards,

Richard Suttmeier

Stay Tuned for Monthly Report

The final edition will be sent out Wednesday morning.

02/28/06 - 12:39 PM EST
Making Adjustments
Stocks in Focus: CSCO, EMC, INTC, TWX

Booking profits in one position and trimming three others.

02/24/06 - 11:07 AM EST
Removing a Hedge
Stocks in Focus: SMH

Suttmeier's closing this protective position, which is no longer necessary.

02/23/06 - 10:11 AM EST
Technology Report Weekly Roundup
Stocks in Focus: CSCO, DELL, EMC, INTC, JNPR, QQQQ, SMH, SYMC, T, TWX, XMSR

The market's resilience continues as almost all sectors remain overvalued.

02/24/06 - 06:17 PM EST

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