The 'Other Market': Some Tech Stocks May Not Have Seen the Floor Yet

If we're talking about looking for a bottom in the market, let's be clear about which market we're discussing.

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Remember back in 1999, when the Nasdaq Composite was playing sandbox bully with the rest of the equity world? At that time, market pundits all noted then that it had become a tale of two markets: Tech, and everybody else. Indeed, Nasdaq soared 85.7% in 1999 -- dusting the 19.5% return on the S&P 500. In 2000, the Nasdaq tanked 39.3%, compared with the 10.1% drop in the S&P.

Now that the market has been badly bruised and people are starting to quietly murmur about a bottom being in sight, the "two markets" paradigm holds true. A look at prebubble, historical P/E multiples suggests that many top tech stocks are still fairly expensive when compared with their forward P/Es for the next 12 months. And if you believe that many of these stocks will never see earnings growth levels of the late '90s, they may be even more expensive than they already appear.

In a bid to find companies that may have further to fall, we sampled tech companies with market caps above $20 billion, a history of earnings from July 1994 to July 1999 and a forward P/E multiple -- meaning analysts expect them to have earnings in the coming year. (Foreign companies that trade as American depository receipts (ADRs) were not included in our lists.)

The first chart below shows how much further stocks would fall if they traded at their pre-bubble P/E levels.

Above the Bubble
Company	Average Historical P/E Ratio (7/1/94 to 6/30/99)	Forward P/E Ratio (EPS 12 months out)	Percent Change from Current Price
Sun Microsystems (SUNW)	21.7	37.5	-42.2%
Motorola (MOT)	37.3	60.8	-38.7
Micron Technology (MU)	19.4	29.8	-34.9
Texas Instruments (TXN)	27.8	40.2	-30.9
Veritas Software (VRTS)	49.6	71.2	-30.3
EMC (EMC)	28.0	38.5	-27.3
Intel (INTC)	21.0	28.1	-25.0
Hewlett Packard (HWP)	15.8	18.7	-15.3
IBM (IBM)	18.3	20.5	-10.5
Electronic Data Systems (EDS)	23.5	25.0	-5.9
Applied Materials (AMAT)	26.8	28.1	-4.7
First Data (FDC)	25.2	25.2	-0.3
Stock prices as of March 2, 2001 Source: Multex.com, Bloomberg

Now, let's take a look at stocks that are trading at P/Es below their historical levels.

Below the Bubble
Company	Average Historical P/E Ratio (7/1/94 to 6/30/99)	Forward P/E Ratio (EPS 12 months out)	Percent Change from Current Price
JDS Uniphase (JDSU)	90.2	36.5	147.2%
Qualcomm (QCOM)	80.0	47.7	67.7
Compaq (CPQ)	26.0	17.3	49.9
Microsoft (MSFT)	45.1	31.3	44.1
Corning (GLW)	28.2	19.8	42.6
Dell Computer (DELL)	35.8	27.3	30.9%
Cisco Systems (CSCO)	43.0	34.4	25.1
Nortel Networks (NT)	30.3	24.4	23.8
Oracle (ORCL)	37.7	33.1	14.0%
Data as of March 2, 2001 Source: Multex.com, Bloomberg

Be careful with this group, one hedge fund manager notes: Even though these stocks are trading below their historical multiples, they may not be screaming buys.

"These guys were working from a much smaller base five to six years ago; their revenues were fairly small," so heady earnings growth was easier to come by, says Mike James, a hedge fund manager at Kuekenhof Capital Management. "Unless there is a new technology or a major change in the economy, these companies will not be able to sustain the growth that they were able to achieve" in their earlier days.

In other words, the law of large numbers has caught up to many of these stocks -- even though they sport forward P/Es that make them appear undervalued vs. their historical levels.

Does that mean the stocks that look undervalued are not buys at these levels? "The economy has slowed and the valuations that were put on the stocks over the last few years did not make sense," James says. "Some of them are great companies, but they are not great stocks to own at these current valuations. I do not see what near-term catalyst is going to make these stocks go higher."

The bottom line, James says: The tech stocks listed that are trading at levels above their historical rates may come down further. And those stocks trading below their historical ranges may not deserve to ever trade at their historical levels again.

"These stocks are cheaper, but based on future growth expectations, they are still expensive," James says. In other words, these tech stocks are cheaper, but they're still not cheap.

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