You remember the old business joke: "We're losing money on every unit, but we'll make up for it in volume." That's a little strong when it comes to
. But the giant PC maker took a hard fall this week -- and took shares of chipmakers and other computer builders with it -- when the company missed top-line expectations despite sizzling unit growth of 25%.
The seeming paradox isn't hard to understand. Dell finally cut prices so much -- and sold so many low-end PCs -- that its famously efficient business model couldn't keep up.
Goldman Sachs hardware analyst Laura Conigliaro downgraded Dell on Friday to in-line from outperform, saying "the strongest growth is increasingly coming from geographies where configurations are typically lower-end and pricing is more aggressive." Operating margins in EMEA (Europe, the Middle East and Africa) dropped to 6.5% from 7.4%, while average selling prices in the Asia Pacific region dropped 9.4%, after falling 6.4% in the previous quarter.
"The probability of either revenue acceleration or margin expansion is much reduced," concluded Conigliaro, whose company has an investment banking relationship with Dell.
Two days earlier, shares of another tech powerhouse took a hit, when investors decided that
revenue-growth projection of about 10% to 12% in the current fiscal year wasn't high enough. Earlier, the networking giant had signaled that it expected to grow as much as 15% this year.
Following the otherwise solid report, investors ran for cover, knocking about 7% off the stock on the heaviest volume in more than two years -- 203 million shares.
Neither company is in serious trouble, of course, but the week's events make it much less likely that investors will see significant share gains anytime soon. Market leaders in maturing markets find it difficult to sustain torrid growth. After all, how many companies in the world throw off anything like the $16 billion of cash
generated in its last fiscal year from operating activities alone? Yet until the stock finally rallied last week, it had languished in the doldrums for years, appreciating by just 21% since August 2002, while the
gained nearly three times that amount.
hasn't done much better, gaining 29% in the same period, while Intel's
showing was stronger at 43%, but still well below the composite.
While the biggest fish were lumbering along, however, the S&P Smallcap 600 Index has done much better, up 72% in three years, 50% over the last two years, and 15% since the middle of May.
That's the kind of news that brings (symbolically, at least) an "I told you so" to the lips of James Satloff, CEO of investment bank C.E. Unterberg, Towbin. Satloff was in San Francisco this week preaching the gospel of small-cap investing.
"Innovation in the smaller companies will be the engine for broader growth," he said in an interview during his company's TechFest investors conference, which featured 47 companies, most with market caps under $500 million.
Satloff is quick to mention that his company is no stranger to the big caps -- in fact it brought Intel, Compaq, Lotus and
Advanced Micro Devices
to Wall Street.
But now, he said, the biggest companies have ceased to be the most innovative, and aren't the place where active investors can make the best returns. In fact, the traditional tech bellwethers are no longer representative of the technology market, he said, "They are too diverse, influenced by too wide a variety of factors."
David Ciruli, managing director of Castle Peak Management, a San Francisco-based hedge fund, makes another argument for the smaller names. "Companies over $1 billion are over-analyzed by Wall Street," he said.
"I always watch Dell. But it's more like an economic indicator than a proxy for tech," he said.
Satloff is careful to warn that the same lack of research coverage that creates an opportunity for some investors makes companies selling emerging technologies very risky for the "passive" investor. Not to mention their extreme volatility.
Case in point:
, a designer of electronics for high-definition televisions that made a presentation at the conference. In the last 52 weeks, shares of the Tempe, Ariz., company have traded between $1.12 and $9.10.
Brillian-based TVs, which sell for around $6,000, have gotten good reviews, use an emerging technology called liquid crystal on silicon, which greatly improves the display. But Brillian's volume manufacturing plans and then its stock price went into a tailspin last September when a supplier of a critical component backed out at the last minute.
Soon after that, the company was forced to go the capital markets to survive. "We were running on fumes," recalls CEO Vincent Sollitto. "We went to the bowels of the market to get survival money."
Sollitto, who formerly headed
, which makes flat-panel inspection, test and repair equipment, got the money in the form of $11.5 million in convertible debentures.
The company solved the software problem that kept its former supplier from building a key HDTV-component, and is now merging with Syntax Group, a privately held manufacturer of lower-end HDTVs that distributes its products in the retail channel. Brillian sells through distributors and high-end installers, so Sollitto figures the combined companies will have the reach they need to get critical mass.
There hasn't been much action in Brillian's stock recently. Investors are likely waiting for Brillian and Syntax to file S-4s, which will reveal Syntax's financial position.
One more point needs to be made here: Small-cap tech and emerging technology are not at all synonymous. In fact, one of the more interesting companies presenting at TechFest --
has a market cap of about $1.1 billion. The 10-year-old company has found a niche providing chips used in a wide range of GPS products.
Indeed, Cody Willard, a partner in a buy-side firm and a regular contributor to
, puts it this way: "I don't see the world through market-cap glasses. It's arbitrary. Almost a marketing tool."
Willard is likely overstating, but in this market it's worth remembering that innovation is a factor investors should be looking for, regardless of a company's size.
The coming week will give investors a bit more information on the state of tech stocks as
reported after Tuesday's closing bill. Most of the software world has already checked in, although
, which has become a star, and
, which badly needs a strong quarter, report Wednesday.