Computer Hardware: Getting Healthier

S&P says the industry's fundamentals are positive. Stock price momentum is another plus. Among its top picks: Apple

The S&P 1,500 Computer Hardware subindustry index is the newest member of the high-momentum list (see the full list at the end of this story), indicating that its trailing 12-month price performance is now in the top 10% of all 136 subindustry indexes in the S&P 1,500. Year to date through May 25, the S&P Computer Hardware Index is up 12.3%, vs. a 7.3% gain for the S&P 1,500. In the past 13 weeks, this subindustry index gained 10.8% to the market's climb of 4.3%.

Take a look at the accompanying chart of this subindustry index's rolling 12-month price performance compared with that for the S&P 1,500. Any point above 100 indicates sector outperformance vs. the S&P 1,500 over the prior year, while points below 100 show sector underperformance. The red line is a rolling nine-month moving average, while the two green bands indicate one standard deviation above and below the index's longer-term mean relative strength.

There are 10 large, mid-, and small-cap companies in the S&P Computer Hardware subindustry index. The two highest-ranked members are Apple (AAPL), ranked 5 STARS (strong buy), and IBM (IBM), which carries a 4-STARS (buy) opinion. Jim Yin covers the subindustry for S&P Equity Research, and has a positive fundamental outlook for the group.

Chip Price War a Plus

Standard & Poor's estimates unit sales of personal computers in 2007 will grow 10%-12% year over year, due in part to the release of Microsoft (MSFT) Vista, for which sales in the first two months of release were better than expected. Yin sees faster growth coming from emerging markets in Asia, Eastern Europe, Latin America, and the Middle East.

The analyst believes many computer hardware vendors have taken costs out of their infrastructure over the past few years, and profitability should benefit from lower component costs as a result of rapidly falling DRAM prices and a price war between Intel (INTC) and Advanced Micro Devices (AMD). Therefore Yin believes the S&P Computer Hardware subindustry index should outperform the S&P 1,500.

Yin sees longer-term fundamentals in the computer industry remaining attractive, as he thinks that a global appetite for technology products should boost productivity and communications. S&P sees global competition forcing companies to be more productive; this, S—P believes, is being achieved largely through technology. Many vendors also streamlined operations during the industry's downturn, and S&P sees this boosting longer-term profit potential.

Higher-Margin Offerings

Yin notes that demand for Internet-based applications is growing; he thinks this is because they offer companies opportunities to reduce costs and improve customer service. Although some initial deployments have been made to capitalize on this opportunity, S&P thinks the evolution of the platforms could produce another wave of investment as Internet use matures. For example, Yin thinks the growing complexity of computing infrastructures should lead to investments in hardware that have self-management features and eventually on-demand or automated computing.

In addition, as price pressures in the PC industry have remained intense, Yin thinks that hardware vendors have been seeking to offset the negative impact on profits by offering higher-margin services, servers, and storage.

So there you have it. The group's longer-term momentum is firm, and the group's overall fundamental outlook is positive, indicating that from fundamental and momentum perspectives this subindustry index may continue to see strong price performances in the period ahead.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1,500 with Relative Strength Rankings of 5 (price performances in the past 12 months that were among the top 10% of the 136 sub-industries in the S&P 1,500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

Subindustry Company S&P STARS Rank Price (5/25/07)
Apparel, Accessories & Luxury Goods Quiksilver (ZQK) 5 $13
Commercial Printing R.R. Donnelley (RRD) 4 $43
Computer Hardware Apple (AAPL) 5 $114
Construction Materials Vulcan Materials (VMC) 2 $117
Consumer Electronics Harman Intl. (HAR) 4 $118
Diversified Metals & Mining Freeport-McMoRan Copper (FCX) 3 $75
Fertilizers & Agr. Chem. Monsanto (MON) 3 $61
Footwear Nike (NKE) 4 $54
Gas Utilities Questar (STR) 4 $104
Integrated Telecom. Svcs. Citizens Communications (CZN) 4 $16
Internet Retail (AMZN) 2 $69
Metal & Glass Containers Ball Corp. (BLL) 4 $54
Steel U.S. Steel (X) 4 $109
Tires & Rubber Goodyear Tire (GT) 2 $34
Before it's here, it's on the Bloomberg Terminal.