Editor's note: This is part 2 of a two-part series.
This is the second part of a two-part commentary regarding McKinsey's article on "Eight business technology trends to watch" and what this might mean for those investing in TheStreet.com Internet Index stocks. If you haven't already done so, click here to read the first article on trends that deal with managing relationships.
Tech Trends to Watch in 2008.
The next two groups of trends have to do with a) managing capital and assets and b) leveraging information in new ways.
First, a few words about the method and tools I use for selecting the potential stock winners in this or any sector.
I score a stock in three areas: momentum, strength, and expectations. The momentum score includes analysis of the company's real economic profit, net changes in shareholder equity and cash flow trends. The strength score considers, among other things, franchise value, profitability and financing self-sufficiency. The expectation score incorporates valuation metrics, new business growth, earnings estimates and management value-added.
While this process can be a bit overwhelming, one very handy tool for getting all this data and creating useful scorecard is
, an online service for business valuation. While the best stocks should consistently score well in all three areas, a company need not score well in all three areas to receive a buy rating. The same is true for sell-rated stocks.
For example, in the case of
which was mentioned positively in the first part of this article, the strengths score penalized the company for its large dividends to shareholders, which is an effective means to manage capital. In fact, managing capital and assets is the next group of trends McKinsey discusses.
5) Expanding the frontiers of automation -- McKinsey writes about interlinking islands of automation where repetitive tasks are computerized and turning these into a new experience for consumers. The goal is to increase sales while decreasing costs. The reality is that some customers get upset at the automation and some customers are happy, but at the expense of lower total returns to the company.
was mentioned as a successful 1990's version of this trend for its online document tracking, a less positive example of the beyond automation trend is
Verisign operates intelligent infrastructure services that enable and protect billions of interactions every day across the world's voice and data networks. This stock has been a darling of investors, up 56% over the last twelve months. If you looked at a chart of this stock, it's practically linear.
But chartists beware!
Top-line revenue and free cash flow have been lower in both of the last two quarters, and the strength scores have been mixed, showing signs of stalling. Yes, there is higher activity, but at lower returns. In fact, VeriSign management announced that for the fourth quarter of 2007, it expects revenue to be approximately $375 million to $385 million, down about 5% from most analysts' forecastings. Meanwhile, 2007 and 2008 consensus earnings per share numbers, $1.00 and $1.19 respectively, have been declining. Future growth gets pushed into 2009, and this stock becomes a sell candidate.
Fundamental investors would say, don't you see they are building for the future? Plus, VeriSign meets the McKinsey trend of automation, but the odds are really against the stock that is again leading the Internet index in 2008.
6) Unbundling production from delivery -- The article mentions
as a prime example of taking your current business assets and looking for other ways to think about what you do. It refers to Amazon letting other retailers use its logistics and distribution services and how this creates value.
Amazon is a great company. The top line is growing quite nicely. For the nine months ended 30 September 2007, Amazon.com, Inc.'s revenues rose 36% to $9.16B. It also has the highest profitability scores among its major peers in the Internet index.
However, the price is at issue. At 83 times 2007 estimates and at more than 300% of the 2009 P/E average for this index, Amazon shares appear a bit expensive. Some have suggested a pullback is in order for tech stocks, and if that is the case, the largest winners will likely have the most to give back, especially with year-end profit taking. Take caution with this 2007 winner.
The final two trends deal with managing relationships:
7) Putting more science into management -- Google and eBay are mentioned in the McKinsey article as companies that might benefit from the creation and commercialization of ideagoras. Agora is the ancient Greek word for marketplace, and an ideagora is a place where ideas and solutions change hands. Think of it as an eBay for innovation.
Look at the best-of-breed company,
(GOOG), with earning estimates for 2009 of $25 per share. These numbers factor in an 87% increase over 2007 not-yet reported results. The stock trades at 53 times 2007 earnings, which is not cheap.
stock price has been up only 8% over the last year, but estimates have been revised upward on this stock by 38% for 2007 and 25% for 2008, according to the Infinancials corporate focus portal. The bottom line is that with eBay you have a much-maligned, underperforming stock that trades in line with its peers at 23 times 2007 estimates, but with a projected growth of 34% to 2009. This undervalued stock sounds like an ideal candidate for Dogs of the Dot for 2008.
8) Making businesses from information -- McKinsey's final trend points to the accumulated pools of data that exist within large organizations or content that can be pulled together from many points of origin on the Web. It sees this flow of information as the raw material for new opportunities.
But it warns that the sword can cut both ways; today's aggregators, for instance, may themselves be aggregated tomorrow.
No controversy here. The most doubt-filled aggregator is
, and the market seems to agree. The stock is down 14% over the last twelve months and sliding. It seems bad news is good news when it concerns the company coming to grips with its failed AOL acquisition.
Two months ago, Time Warner reported that its Internet unit, AOL, will cut about one-fifth of its global work force. Last month, the company announced that CEO Executive Richard Parsons will step down and be replaced by Chief Operating Officer Jeffrey Bewkes. Expect 2008 to be a stabilizing year for the company and another year of disappointments. Time Warner's real identity remains an enigma. But even assuming it's really a broadcaster with a lower earning multiple like
, it still appears overvalued.
In summary, dump Amazon and Verisign, the two winners from 2007, avoid Time Warner and buy Microsoft or eBay.
These are the 21 current members of theStreet.comInternet Stocks (symbol=DOT on the Philadelphia Exchange) as of 12/7/2007.
1. Abode Systems
4. Check Point Software Technologies
5. Cisco Systems
7. FedEx Corp
9. HLTH Corp.
11. International Business Machine
13. McAfee Inc
15. Monster Worldwide Inc
16. Oracle Corp
17. Research in Motion Ltd
18. Symantec Corp
19. Time Warner
20. VeriSign Inc