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Hot Stocks: IBM Bucks the Earnings Trend as Tech-Sector Stocks Trade Down to Bargain Levels

By , Executive Editor, Money Morning •

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[“Hot Stocks” is a new Money Morning feature that analyzes the investment outlook of global companies that are in the news. This is the inaugural installment of this new investment series.]

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

After watching its shares plunge more than 20% over the past month, International Business Machines Corp. (IBM) decided to embrace a different strategy with regards to its looming third-quarter profit report: It opted to get out in front of the flood of corporate earnings reports that are headed this way by providing Wall Street with a preview of its third-quarter results.

IBM, otherwise known as “Big Blue,” on Wednesday told Wall Street that it expects to post a better-than-expected adjusted profit of $2.05 a share for the third quarter. That compares with pro forma earnings of $1.68 in the year-ago period and is above the Wall Street consensus forecast of $2.01 a share. Sales for the quarter – which ended last month – were $25.3 billion, up from the $24.1 billion level last year, but below top-line expectations of $26.5 billion.

IBM, the world’s biggest computer-services company, said its service contract business remained solid and reaffirmed its full-year profit goal, Forbes reported.

The announcement was made after regular trading ended Wednesday. The shares were up 5% in after-hours trading.
But some investors remain concerned that the current financial crisis will force businesses buyers to scale back on their purchases of high-tech hardware. Tech-stock mavens of both the bullish and bearish persuasions will tune in next Thursday to see if IBM can fill in the blanks when it releases its full earnings report.

“IBM's pre-announcement attempts to put out the fire sale,” since Wall Street has taken a highly pessimistic view of the U.S. tech sector, preferring instead to sell now rather than waiting out the credit-crisis storm, said Mark Moskowitz, an analyst who follows the high-tech sector for JPMorgan Chase & Co. (JPM), wrote in a research note yesterday (Thursday).

As one of the key beneficiaries of the so-called “outsourcing” trend in the information-technology-services sector, IBM has been somewhat insulated from the tech-spending swoon. But a new report released Wednesday from Forrester Research Inc. (FORR) suggests that there are more challenging times ahead.

According to Forrester, 43% of the firms it surveyed have already cut IT budgets in anticipation of an economic slowdown, and 70% are looking to spend even less. Recent shakeups in the insurance and financial-services industries are finally prompting potential customers to delay orders – or even to cancel them outright. And now some analysts see signs that the financial-sector-fallout is going to show up in IBM’s results.

Forrester analyst Andrew Bartels predicts that the third-quarter's banking woes won’t materialize for tech companies until the fourth quarter.

“We've been expecting vendors would have a relatively solid third quarter," he told Forbes. "There's a lag when economic news hits. At the end of a quarter, companies look at their own earnings and realize they're going to miss their numbers, and it's only then that tech spending slows down.”

In a research note yesterday, Sanford Bernstein & Co. LLC analyst Toni Sacconaghi wrote that: "IBM's revenue shortfall likely came late in the quarter due to increased purchasing hesitancy, and may have been concentrated in consulting and short-term services revenues, particularly in financial services.”

IBM isn’t alone among high-tech firms that have seen their shares tank: Even such highly profitable high-tech giants as Nokia Corp. (ADR: NOK), Dell Inc. (DELL) and Verizon Inc. (VZ) have seen their share prices drop so much that they each are now trading at a Revenue/Price ratio of less than 1.0 – one indicator of a possible bargain-stock play used by value investors.

For example, Nokia's Wednesday closing price of $16.61 per share is considerably less than its Revenue/Share ratio of  $19.19, based on the past 12 months of sales, Fortune reported, giving it a Price/Revenue ratio of 0.87.

Six years ago, Nokia’s Price/Revenue ratio was 2.1.

Nokia’s market value of $61.91 billion is below the cell-phone giant’s yearly revenue of $73.2 billion (creating a Market Value/Revenue ratio of 0.85).

Although a number of tech-sector firms have fallen into this potential bargain-basement realm, Fortune says that these four firms stand out for their “otherwise solid financial positions and leadership in their [respective market] segments,” or sectors.

And this huge “revaluation” has been somewhat indiscriminate. Nokia, for instance, has $10 billion in cash on its balance sheet and generates another $9.3 billion in operating cash flow each year, says CNNMoney.com.

“We are seeing values significantly lower than the last cycle, and the earnings are higher now,” Bay Bridge Capital's Scot Labin told Fortune. “I don't think it's anything specific to these companies … I think it's hedge funds dumping shares and people going to the sidelines.”

And the tech area isn’t the only market sector to be torpedoed. Media shops like CBS Corp. (CBS) and Time Warner Inc. (TWX) also are valued at less than their yearly sales level. It won’t stay that way forever, Labin says, insisting that reason will eventually return to the market.
“Those companies, which stuck with financial discipline and made acquisitions that provided adequate returns on capital, will be significantly rewarded over the next few years,” he said.

Ironically, yesterday marked the six-year anniversary of the Nasdaq Composite Index’s most-recent low, when the tech-laden index fell to 1,114 – as the last bit of helium left the Internet bubble that reached its peak from 1998 to 2000. Even at yesterday’s closing of 1,645.12, after a drop for the day of 5.47%, the Nasdaq still trades well above that 2002 nadir, Fortune reported.

“There are problems out there, I know that, but stocks have completely overshot on the downside and are now discounting some bad economic conditions,” Kevin Rendino, who manages $10 billion at BlackRock Inc. (BLK) in Plainsboro, N.J., told CNNMoney.com. “There are a number of companies that offer unbelievable risk-reward potential.”

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Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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