Charted Territory: How to Play the DVD Revolution

Gary B. and readers think digital video disk technology is going to be big. Here are some stocks they're looking at.
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Friday, I profiled a few DVD stocks a reader mentioned,

Sigma Designs

(SIGM)

and

Sonic Solutions

(SNIC)

, and asked for other suggestions from our ever-astute

TSC

subscribers.

The suggestions came flying in. So, today we'll revisit the DVD video technology arena, using both fundamentals and technical analysis, with the hope of finding yet another winner.

But before we get to those, a few SIGM diehards want their final say:

Standing by Sigma

Gary, Yes, SIGM could be a great play for 1999 and beyond. Charts can never explain exponential growth of exciting new technology, as evidenced by Qualcomm (QCOM) - Get Report (with CDMA digital mobile phone technology) and RealNetworks (RNWK) - Get Report (with video streaming). The story on DVD is becoming more and more clear: A software solution is just not superior to a hardware solution. And SIGM has a superior hardware solution. You will most likely not receive many emails concerning this stock. What is most important to remember is this: Check their partners. SIGM may well become a piece of every video solution in the future. Its solution is already becoming a standard for many of the big original equipment manufacturers, or OEMs. I have held this stock for three years and continue to add to my position on dips. The future is bright for this company. -- Steve Smith

Sigma by Any Other Name...

Gary, Glad to see your article included SIGM. A couple months ago, I wanted to get into a DVD stock, did my research and came up with SIGM as my best bet for a true DVD play. One of the problems I've found looking for a DVD play is that the most obvious choice is the set-top boxes, but they are all made by huge companies like Sony, Panasonic, Samsung, etc. The closest I could find is companies that make specialized components for set-top boxes and DVD drives in PCs. SIGM caught my eye in particular because the shares are so underloved. The company's closest competitor is Zoran (ZRAN) , which is trading for 300% to 500% more than SIGM, despite having less revenue than SIGM and not being able to make a profit in the past two quarters. As close as I can figure out, one of the biggest reasons that SIGM is underloved is because of its name. It took me a week before I could remember the company's boring name and symbol (while I remembered ZRAN after reading it once). This brings me to the point of my email: In SIGM's conference call, they pretty much confirmed rumors that the company was changing its name to something more snappy and that they plan to do it before the end of the calendar year. Like you, I don't like the current technicals of SIGM, but with only 17 million shares outstanding I decided to put a little speculative money in it, with more to follow if the stock does break out. With institutional ownership low and no analyst coverage, when (and of course if) this stock does move, I think it will go big (taking for granted the name change). -- Brian Wire

OK, that said, I stand by my SIGM call: It's just not ready yet. Other plays, though? Plenty, as you can see below.

In the Zomax Zone

C'mon Gary, The DVD play is right under your nose. In fact, I believe

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covered it more than once this last year. It's ... drumroll please ... Zomax (ZOMX) , a leading manufacturer of DVDs and software and a large minority holder (something like 28%) of what I believe is the No. 2 software commerce site, Chumbo.com. Zomax has done very well this quarter: great earnings, good stock movement and breaking its 52-week high. If and when Chumbo.com goes public, well, watch out ZOMX. What do you think, Mr. G? -- Perry Tessel

Check Out CUBE

Gary, Look at C-Cube Microsystems (CUBE) - Get Report. This company's semiconductor division produces chip sets used in DVD players. CUBE has a 51% share in the MPEG-2 chips used in DVD players and set-top boxes. It also has a division that is involved in digital broadcast encoders, multiplexers and network systems management equipment. The stock has made a move up recently. I don't know if it's a sure bet, but every one of the Smith's DVD players will probably have a CUBE chip in it. -- Charlie Kelt

Thinly Traded Cinram

Gary, I have found three companies that are somewhat involved in manufacturing and production. They are Sony (SNE) - Get Report, Carlton Communications (CCTVY) and Cinram (CNRM) . I am new to trading, so I'm not sure if I'm doing the right research with these companies. What I do know is that I would like to invest in a stock involved in DVD. Everything I have seen about Cinram makes me want to invest, such as its acquisitions in Europe, Latin America and North America. This company seems to have a strong management background and looks to want to grow in the DVD production market. But earnings don't seem too hot. I would very much like to hear your opinion on this matter. There hasn't been much trading: Volume was 1,500 shares yesterday, and before that, absolutely no volume for months! What does this mean? -- Ed Y.

Software Play

Gary, How about a media supplier instead of hardware, such as Image Entertainment (DISK) ? Its last quarter was lousy though sales were way up. The explanation: Problems and costs associated with a new warehouse and a new distribution system kept it from being as profitable as it could have been. The problems have since been corrected. I believed them and bought more. Love to know what you think. -- Jim Yoshii

Another Z-Play

Here is a quote from Kevin Landis of Firsthand Funds: "We are also big players in a stock called Zoran (closed Aug. 30 at 31 1/2). They are a chip company that has important design wins in DVD players." -- Bernie Lomax

In summary, then, we have five new candidates. I'd rule out CUBE, DISK and CNRM immediately, though. CNRM is just too thin, and the other two look pretty weak right now.

That leaves the two Zs, and both have pretty good-looking charts. My favorite, by a nose, is ZRAN, but only because it's hugging the trend line a bit closer. But ZOMX isn't bad either, and I'd be tempted to go with both.

Judging from the fact we just added four more DVD disks to the Smith collection, I'd be shocked if one or both of these stocks wasn't higher a year by now.

So, if the DVD bug hits you, and you go long one of the stocks I profiled, think about your entry and exit. I always like to enter on some sort of technical analysis indicator, with a breakout being my favorite. Then you need to think about your exit. Of course, a 50-day moving average is effective as a trailing stop, but a trend line works well also.

My gut says DVD will get even hotter, and I'm betting at least one of the aforementioned stocks tags right along.

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide investment advice or recommendations, he welcomes your feedback at

gbsmith@ibm.net.