If you listen closely, you can hear the whisper: "Buy on the dip."
For months, cash-flush investors have been itching for the stock market to pull back, and the current dip is starting to look just like the opportunity they've been praying for. You can almost hear their keyboards clicking away as they place their trades online.
But let's be honest. A 10% correction isn't going to take the froth out of the technology stocks that have led this rally. At its high on Sept. 8,
, for example, traded for 187 times projected 2004 earnings per share. After dropping 11% by the close on Sept. 25, the stock traded at 167 times projected 2004 earnings. And if it falls all the way back to its Aug. 6 low of $10.81, a 28% drop, it will still trade at 135 times projected 2004 earnings per share.
Buying stocks like this on a dip of 10% or even 28% isn't about fundamentals or valuations. A buy-on-the-dip strategy at these price levels is a bet that the sidelined cash will flood the market and send the multiple on PMC-Sierra back to its peak or even higher. It's speculation that this rally will make at least one more run in 2003.
It's an interesting speculation, and the odds are that the market will make that year-end run. But speculation isn't for everyone; in fact, it's not for most people. What about investors who are looking for stocks with some kind of fundamental underpinning but who would like to participate in any year-end, momentum-based rally? Are they shut out of technology stocks, or are there a few names that combine almost-reasonable valuations with the potential for solid momentum?
A slim few. I call 'em "cheap-enough tech picks," and I've found three. Maybe they aren't cheap enough to interest a value investor, but they are trading at reasonable prices given their growth potential over the next year and five years. In the short term, all have the potential to climb along with any end-of-the-year tech rally.
And these stocks come with an added edge: Because of the markets they're in, the way their businesses are organized or their competitive positions, they're more likely than the average tech stock to actually deliver the growth now projected by Wall Street analysts.
A Chipmaker With Real Growth Prospects
is the prototype of a cheap-enough tech stock. After dropping 9% from its Sept. 8 peak to $38.95 on Sept. 25, shares of Analog Devices traded at 33 times projected earnings per share for the fiscal year that ends in October 2004. It is certainly not value-investor cheap, but the multiple is reasonable, in my opinion, for a stock projected to grow earnings by 49% in fiscal 2004 and at an annual average of almost 20% for the next five years.
Because the company engineers customized analog chips (meaning it has a customer waiting for delivery of a particular application or product in mind), the growth is likely to materialize. Many of Analog Devices' analog products are "single source" with no competition. That leads to long and stable revenue streams for analog products. So, for example, Analog Devices saw sales fall only 25% in the fiscal year that ended in October 2002. Not bad compared with the bloodbath at many chip companies. With industrial applications accounting for about 40% of sales, that stability gets another boost.
That isn't to say that Analog Devices doesn't play in the more volatile digital market or in the most volatile communications market. The company is No. 2 to
in digital signal processor chips (DSPs). Recent signs point to a modest pickup in both the industrial and communications DSP markets, and any increase in sales will put more of Analog Devices' capacity to work -- analog capacity utilization is now just 50% -- and drive margins higher.
Going With the Trend to Move Offshore
The trend to move more and more jobs out of the U.S. and offshore is one of the reasons that the recovery in the information technology sector is proving so slow and why future growth rates for companies in the sector are still overoptimistic. With customers able to save 25% to 75% by moving everything from data warehousing to call centers overseas, the appeal in an era of constant cost-cutting pressures ensures that the trend will only get hotter. I'd rather be an investor on the side of the companies profiting from this trend than those fighting it. And that's what puts
Cognizant Technology Solutions
on my cheap-enough radar. The company's onshore/offshore information technology strategy combines management teams located on customer premises in the U.S. or Europe with low-cost offshore service centers in India and Ireland that do the actual information technology work.
The stock certainly isn't cheap. It trades at 35 times projected 2004 earnings even after its recent pullback. But, for that price, an investor gets a stock projected to show earnings growth of 26% a year in 2004 and average earnings per share growth of 27% annually over the next five years. With projected revenue of just $358 million in 2003, according to UBS, Cognizant is in the early stages of its growth curve. Projected 2004 revenue, according to UBS, will be $486 million, or 36%, higher. Add that to the company's position riding one of the strongest trends in technology today, and those growth projections look very doable.
The Bar-Code Printing King
dominates the market for specialty thermal printers used to print bar codes on just about everything. With about 30% market share, by far the biggest player in the market, Zebra is one of the few companies with the financial resources to push complex new products into its market. It also stands to gain from a number of broad trends: the increasing use of bar codes to track new categories of products such as pharmaceuticals; national security concerns that have led to the increased need to track objects and goods; and new products that embed a tiny radio transmitter in the bar code to enable real-time product tracking and identification.
Wall Street currently estimates that earnings per share at Zebra will grow by 22% in 2003 and 14% in 2004. I like the modesty of that estimate and the projected consistency of Zebra's earnings growth: an average of 15% a year over the next five years. The stock trades at just 23 times projected 2004 earnings per share.
When Is the Time to Buy?
Where would I buy each of these three stocks? The answer is based on the volatility of each and the way the stock market unfolds over the next few weeks.
These stocks have wildly different volatility. Zebra Technologies is by far the tamest -- with a beta of 0.8 it has only 80% of the volatility of the market as a whole. If stocks move up or down 100, Zebra is likely to move only 80. That plus the stock's relatively low price-to-earnings ratio makes it the least risky pick of the three.
Cognizant Technology Solutions, with a beta of 1.9, and Analog Devices, with a beta of 2.8, will climb far faster than the market as a whole -- and also fall much further.
That's why it's important to examine any buying decisions in the context of the developing test of this rally. How far down will the market averages fall?
So far, as of the close on Sept. 26, the current correction had taken the
down just about 6%. More important, the index had retraced about 40% of the rally from the August low at 1,644 to the September high at 1,910. It's not unusual for markets to retrace 38% or 50% of a rally, and I don't think anyone on Wall Street will get particularly nervous about the health of this rally unless the Nasdaq violently breaches 1,777 to 1,773. That level corresponds to a 50% "giveback" of the rally from the August low to the September high and also represents the 50-day moving average for the index. If the index looks like it will hold above that level, investors will decide if this is a run-of-the-mill correction in an ongoing rally and rush to put cash to work.
Stocks aren't even in trouble if they move below that level to, say, 1,667. That level marks a 38% retrenchment of the 639 points the Nasdaq has tacked on since its March 11 low at 1,271. It also marks a level about 20 points above the August low at 1,644. If the market tests this level and then begins to move up again, Wall Street will decide that we've put in one of those reassuring higher lows and that the rally is, again, intact.
Given the end of the quarter next week and the end of the fiscal year for mutual fund managers on Oct. 31, I think it's unlikely that the current retreat will stop at 1,777. That's just 20 points below the Sept. 26 close.
But since there's so much money on the sidelines itching to get into the market, that level could hold. So I'm establishing two sets of target prices for buying into a year-end rally, depending on how this correction develops over the next week or so.
If the market holds near 1,777 and then rebounds, I'd look to buy Zebra Technologies near $50. If the market goes back to test the August low, I'd look to buy near the stock's 200-day moving average of $45.
For Cognizant Technology Solutions, if the market holds near 1,777, I'd be looking to buy near the stock's 50-day moving average of $33. If the correction is deeper, I'd be willing to settle for a buy at $29 but hoping to get shares at $25.
And for Analog Devices, my shallow-retreat buying target is $36, and my deeper pullback target is $32.
I wouldn't worry about hitting these targets on the button. The point is to buy low enough to limit risk but to participate in an end-of-the-year technology rally if one looks likely.
I'm not looking for the absolute bottom. Just a price that's cheap enough.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.