Didn't We Just Get Done With This? Preannouncements Begin

Fund Junkie: Weigh Your Tech Exposure and Consider a Diet

David Gaffen: Tech Stocks Not Cheap Yet

Justin Lahart: Margin Debt at Worrisome Levels

Jim Cramer: Get Liquid

Brett Fromson: Get Ready For Fourth-Quarter Pre-Announcements

Technical View: A Lesson in Tops for a Market Ready to Bottom

Metrics View: A Dozen Stocks Still Defy Gravity

Taskmaster Chat: Take a Defensive Posture

Fund Junkie: Climate Is Changing for Net Bellwether Stocks

Tech investors should get ready now for fourth-quarter preannouncement season. In fact, it's already started.

Yesterday, TelCom Semiconductor (TLCM Quote) warned that Q4 revenues will be about 10% lower than the prior quarter. (TelCom, which sells a lot of chips to cell-phone companies, led off the third-quarter preannouncements as well.) And given the unexpected misses in the past week by two of the better tech companies -- Dell Computer(DELL Quote) and Hewlett-Packard (HWP Quote) -- investors must assume unpleasant surprises ahead for lesser corporations.

The coming announcements could well hit tech stocks like another wintry blizzard of cold news. Only someone in complete denial can fail to realize that the meaning of the third quarter is that we are staring at a dramatic slowdown in technology revenue and earnings growth.

If you doubt that, listen to what First Call/Thomson Financial research director Chuck Hill said to The Wall Street Journal earlier this week: "Earnings expectations haven't come down this fast since the end of 1997 and the first half of 1998, and they're likely to keep coming down in the weeks ahead. This isn't just fine-tuning. It could pick up speed and snowball."

While Hill was talking broadly about the market, tech investors should pay attention because they are invested in the priciest stocks with the greatest sales and earnings expectations built in.

It's not all bad, though. The next 90 to 180 days also may present investors with decent buying opportunities in tech land.

Let's break this preannouncement period down a bit.

The first thing to focus on is that earnings and revenue growth in most sectors of tech are weakening. Analysts are ratcheting down their expectations in most areas. In past slowdowns, such pan-sector markdowns have not tended to be the case. PC sales growth might have slowed, but cell phones were roaring ahead. Today, we have growth slowdowns in PCs, cell phones, semiconductors and networking equipment. And don't forget the unfolding disaster known as telecommunication services. So it is quite possible that we will see preannouncements from a host of tech sectors.

Second, the Securities & Exchange Commission's new Regulation Fair Disclosure has made preannouncements more likely. Here's why. FD means that companies can no longer selectively give an advanced heads-up to a few favored Wall Street analysts, who then quietly reduce their growth expectations for the company and reassure investors.

In reaction to Reg FD, corporate management has been providing less guidance to the analysts, which suggests that the analysts' models will have less predictive power than they had before. Add to that the fact that analysts tend to be behind the curve in downturns, and you have an increased chance of "negative surprises." (Don't you just love that phrase?)

Add It Up!

Now, about valuation.

The problem with trying to solve the tech investing equation today is that, as Fred Hickey, the always-skeptical editor of The High-Tech Strategist newsletter, says, "We are coming out of a mania for tech stocks, and we are still in the process of correcting that excess. You have to care about price when you buy tech stocks now."

He's right, of course. The days are long gone when you could simply buy a growth story without any regard for the present value of a company's future earnings prospects.

Tech investors, in fact, all growth stock investors, tend to focus on forward P/E's. That's understandable, because when you buy a supposedly good grower, the whole point is strong future growth. On that basis, i.e., forward P/E's and the like, the bulls say that tech stocks that are well off their highs are already worth buying. That may be the right way to pick tech stocks in general, but at the moment, P/E's based on expectations may not be wise.

Talk to experienced tech investors, and you will find out that few believe most of Wall Street's 2001 growth estimates. They fully expect those to get shaved by year-end or by January at the latest. The obvious implication of that is that the tech P/E's that have compressed will expand again as the "E" dwindles. Then look for the "P" to dwindle, too.

Instead, you may want for the next several months to focus on historical P/E's, for example, trailing 12 months. They may give you a more realistic sense of what a company can do.

How low can historical P/E's go for many tech stocks? Lower, if you look at what they have been in past tech slowdowns. (They do occur, you know.) Look at what happened to Dell, for instance, the last time we saw a PC slowdown, in the 1993-94 period. The company's trailing P/E slipped to around 10.

Today, the comparable P/E for Dell is about 30. That does not mean the P/E has to return to those depressed levels. You could argue that Dell deserves points for having established itself as the leading PC company, and that it is a must-have today for the large institutions. Let's say that is true. Look for the trailing P/E to decline by the first quarter of 2001, but don't necessarily look for it to go back to 10.

That's where the silver lining may be for investors. We may well be closer to the bottom than it feels in a lousy market like this. But are we there yet? The coming preannouncement period is likely to slam a bunch of companies. That may be a better time to buy than today. If you know your companies, you may be able to pick up companies selling at P/E's pretty close to their growth rates. Then perhaps you may get the double dip the tech investor loves -- getting at a reasonable price a company whose profit margins might expand as revenue grows.

It is likely that companies -- in response to Reg FD -- will be more conservative in their earnings and revenue guidance. So six to 12 months from now, we might even see some positive earnings surprises in tech. When that inflection point comes, then we can all go back to using forward P/E's.

So it's not all bad news ahead, even though it may sound like that when the preannouncement season hits. To use a Cramerism -- "Don't fight the tape here." But be ready to pounce when there is panic in the air, and before reasoned calm returns to the market. You still have time. Use it wisely to find leading companies in sectors you like for the next three to five years.

There is, unfortunately, one giant wild card to keep an eye on. If the soft landing morphs into a hard landing, then the impending, worrisome preannouncement season may be the first of many. The chances of that have increased recently. Tech companies do grow faster then gross domestic product. That's why we buy them. But in a recession, everyone gets hurt, including growth companies.