Investing: Turning Gizmos Into Gold

Like Jackie Brown, the stuck-in-the-'70s heroine of Quentin Tarantino's latest flick, I entirely missed the move from vinyl LPs to compact disks. That was true until last Christmas, when Santa brought my 8-year-old a CD player. Pathetic, I know. But soon it dawned on me that if I'm the last person around to get CDs spinning in my home, a new wave must be sweeping across the consumer electronics biz. What is it, I wondered, and how might it be ridden profitably in the stock market?

As BUSINESS WEEK's personal-technology report shows, plenty of gizmos, from digital video disks (DVDs) to high-definition television (HDTV), are ready to alter your living room. So I set out to pinpoint stocks of companies that figure to profit from such products.

I knew the dangers. Remember Go-Video? In 1988, it captured investors' imaginations with VCRs that could copy videotapes. Huge market, right? Well, litigation with foreign VCR makers ensued, and Go-Video shares, which that summer briefly hit $24.50, began a sickening slide to 50 cents. Go-Video put its legal woes behind it, moved into high-end audio and digital TV, and is profitable. Yet the stock is still about $2.

To find something with more staying power, I turned to Value Line Investment Survey's database of 5,094 stocks. I began by ruling out smaller companies, those with market capitalizations under $200 million or trading at less than $5 a share. Using those filters, and focusing on companies directly related to consumer electronics, I ended up with just 76 on the list.

I winnowed that further by eliminating any company that wasn't generating cash or whose stock is trading at a multiple to cash flow of 10 times or more. Why 10? Only to leave a wide margin of safety vs. the group's current average multiple of 14. I ended up with four names, surprisingly diverse: Harman International, Harris, Matsushita Electric, and Philips Electronics (table).

Harman, with $1.5 billion in sales from sound-system brands including JBL and Infinity, is one of those little-known companies beloved by value investors such as David Schafer of Strong Schafer Value Fund. The stock tumbled recently because "they're getting a little pressure from Asian competitors," Schafer says. But he's hanging on. He likes Harman's expanding business in the automotive sector, where it sells high-end sound systems to the likes of Toyota and BMW. Harman's profits have grown steadily since 1991, when it posted a $19.8 million loss--a reminder of the risk a recession holds for this stock.

Harris is more broadly diversified, with big chunks of its $3.8 billion revenue coming from specialty semiconductors and software systems. Just the same, it's counting on the HDTV broadcast equipment market to become a key source of earnings. It sees U.S. sales totaling $6 billion between now and 2006, when broadcasters are due to make the switch from analog transmission. Harris expects to take 75% of that, or an average of $560 million a year. One caution: Until broadcasters let loose their capital outlays, sizable profits will remain elusive.

WIMPY. Matsushita's $68 billion in sales from brands such as Panasonic make it a consumer-electronics powerhouse, but its stock has been a wimp--its American depositary receipts are down 25% since last summer. The cheapskate value investors at Tweedy, Browne think it's a steal. At current prices, it's trading for roughly 50% of its inherent value and much cheaper than archrival Sony, which goes for 11 times cash flow. "Matsushita has a lot more return potential," says Tweedy partner John Spears. And as a leader in DVDs, it's positioned to profit as the format catches on.

Dutch electronics maker Philips does more than $40 billion in business annually and, like Matsushita, has many hopes pinned on DVDs and another new device, CDR, or recordable CDs. Star international stock picker Helen Young Hayes, who runs the Janus Worldwide fund, is betting big that a broad restructuring will get sales and earnings growing at nearly 20% annually, faster than Philips' current price-earnings ratio of 11 implies. Philips shares also are 25% below their highs in October.

Are these stocks sure to go up? No, but each is worth a serious investor's research. Just don't wait until Jackie Brown comes out on DVD.

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