Investors in computer stocks such as Compaq Computer Corp., Dell Computer Corp., and Gateway 2000 Inc. face their first reality check in more than a year.
At issue is the perennial question facing investors: Is it time to dump your holdings and head for the hills, or charge in and buy? Some professionals view the recent decline in computer stocks as an inevitable consequence of their phenomenal growth; others believe it's a harbinger of something more sinister.
The month of October was especially bleak for technology stocks. In three weeks, shares of Compaq fell $17 per share, or 22 percent from their 52-week peak, to $61.38. It was a similar story for Dell and Gateway as both stocks also rode a tremendous spike through the summer, only to fall like so many autumn leaves when the weather changed.
Compaq's recent slide is perhaps the most intriguing. Fundamentally, this is the same company that made a mockery of analysts' estimates in the third quarter as it catapulted to new highs.
"Compaq continues to gain market share, and there's not a shred of evidence to indicate that consumers are suddenly going to stop buying PCs," said Jim Meyer, an analyst at Janney Montgomery Scott. "I thought they were a great buy at $75 and I think they're a steal at $61."
Compaq's revenues and earnings have gone straight up in the past year, peaking last quarter at $6.4 billion and $517 million (or 66 cents per share), respectively. Analysts expect the company to post revenues just short of $8 billion in the fourth quarter, almost doubling sales from the year-ago quarter.
So what's the deal?
"I think the extraordinary growth seen in the middle of this year set some unrealistic expectations," Meyer said. "For momentum investors who realize this, the slower growth might turn them off. I guess growing at only 20 to 25 percent a year is viewed by some as a travesty."
This extraordinary growth Meyer alludes to caused Compaq's stock to shoot up from $40 per share in July to its peak of $78 in early September.
Several factors contributed to this groundswell in PC demand, factors which aren't likely to occur again in the foreseeable future, according to analysts.
First, Intel Corp. cut prices on its high-performance Pentium microprocessors to clear inventories for more powerful Pentium Pro and Pentium II chips. Lower-priced chips meant consumers could get more bang for their buck and PC vendors could pass along their savings.
Also, Compaq initiated aggressive price cuts of its own to clean out old inventory. Combined with its move to emulate Dell's build-to-order distribution plan, that meant consumers could get top-of-the-line PCs for 20 to 30 percent cheaper than they could only three months earlier.
Well, Intel isn't planning any significant price cuts in the near future and Compaq has cleared out most of its older machines. Bargains can still be had during the Christmas buying season, but that could be the last surge for PC sales for at least six months.
"I still have a 'buy' rating on the stock, but it's still expensive," said Louis Mazzucchelli, an analyst at Gerard Klauer Mattison. "But if you want to play in the PC segment, Compaq's the stock to have."
Mazzucchelli said the worldwide consolidation of market share and Compaq's breadth of products make it a compelling investment.
"People are still trying to sort things out in respect to technology stocks," he said. "Sure, the stock isn't going to double in three months like it did in the summer, but it should maintain a steady upward trend for a long time."
Compaq officials certainly believe in themselves. Last month, chief financial officer Earl Mason predicted the company would eclipse the $50 billion mark in annual revenues by the year 2000.
Of course, the bold prediction sent the stock skyward. Now, investors are asking themselves if the goal is realistic or just fodder for the press.
"Compaq's up there with the big names in the industry and they certainly deserve the high valuation they are receiving," said Wendy Abramowitz, an analyst at Argus Research. "When they set a target of $40 billion by 2000, that was very achievable internally. They could get to $50 billion, but that will likely mean another outside acquisition."
First Call consensus expects Compaq to post a fourth-quarter profit of 84 cents per share on sales of about $8 billion.
"Even if the sweet spot for PC sales is history, and I think it is, Compaq will continue to gain market share and the stock price will react accordingly," Meyer said.