Computer Hardware: Still in Sleep Mode

While stocks in the sector have surged lately, S&P doubts that the strength can be sustained in the near term

By Sam Stovall

Thanks to a recent surge in computer hardware stocks, that group has joined the -- the list of industries with top Standard & Poor's Relative Strength rankings. Year-to-date through June 20, the S&P Computer Hardware index gained 17.8%, vs. a 13.1% rise for the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes). The hardware group is recovering after a disappointing 2002, when the industry index fell 29.9%, vs. a 22.5% drop for the S&P 1500, as stocks reacted to a weak economy.

Even though the subindustry index' recent outperformance has been encouraging, Megan Graham-Hackett, the analyst who follows this group for S&P, questions whether that strength can be sustained. She doesn't see any signs of a pickup in information technology (IT) spending nor any indications of a corporate upgrade cycle in PCs.

As a result, S&P is neutral on the group, since stock valuations aren't compelling in light of projected growth of 3% in IT spending and 5% in global PC unit sales for 2003. These factors will mean limited revenue growth opportunities for industry players in 2003, in S&P's view.

NET EFFECT.

  However, S&P sees the long-term fundamentals in the computer industry remaining attractive, reflecting a global appetite for technology products that should boost both productivity and communications. Graham-Hackett notes that global competition is forcing businesses to be more productive, a task that's being achieved largely through the use of technology. Also, many hardware vendors have streamlined their operations recently, which should boost profit potential once demand picks up.

Graham-Hackett says the benefits of Internet-related computing for the computer industry may be in their early stages. Demand for Net-based applications is growing, as they offer companies opportunities to reduce cost and improve customer service (see BW Online, 6/24/03, "Will Web Services Click?").

Although some initial deployments have been made to capitalize on this opportunity, the evolution of these platforms could bolster another wave of investment as the use of the Internet matures. For example, the processing power required to analyze a wide variety of data collected by Web sites could boost demand to expand existing computing infrastructures. Indeed, the growing complexity of these infrastructures could lead to investments in hardware that has self-management features.

PICK OF THE CROP.

  Furthermore, as price pressures in the PC industry have intensified, hardware vendors have been seeking to offset the negative impact on earnings per share by offering higher-margin services, servers, and storage.

S&P's top choice among stocks in the hardware group? Graham-Hackett believes IBM (IBM ) is attractively positioned in light of the trends cited above, and she has a 5-STAR (buy) recommendation on the stock.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of June 20, 2003.

Industry/Sector Company S&P STARS* Rank
Biotechnology/Health Care Amgen (AMGN ) 5 STARS
Computer Hardware/Info. Tech. IBM Corp. (IBM ) 5 STARS
Computer Storage & Peripherals/Info. Tech. Storage Technology (STK ) 4 STARS
Construction & Farm Machinery & Heavy Trucks/Industrials Deere (DE ) 3 STARS
Consumer Electronics/Consumer Discretionary Harman International (HAR ) Not Ranked
Health Care Supplies/Health Care SurModics (SRDX ) 4 STARS
Internet Software & Services/Info. Tech. Yahoo! (YHOO ) 1 STAR
Office Electronics/Info. Tech. Xerox (XRX ) 2 STARS
Reinsurance/Financials Everest Re (RE ) Not Ranked
Water Utilities/Utilities Philadelphia Suburban (PSC ) 4 STARS
Wireless Telecom Svcs./Telecom Svcs. Nextel (NXTL ) 5 STARS

* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (strong buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).

Stovall is chief investment strategist for Standard & Poor's

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