It’s time we add a new subsector to technology. Along with hardware, software and chips, the latest category could well be “Victims of Apple and Google.” As the two monsters of innovation grow more dominant, many other companies are seeing their products and services marginalized. The result has been an expanding roster of stocks that investors need to avoid despite their tempting, single-digit P/E ratios.
These companies, while very different in terms of their individual business, are similar in that their inability to adapt leaves little room for significant near-term appreciation in their stock prices. Cheap stocks that need to be put on investors’ “don’t buy” list are:
That these companies represent such a broad swath of the technology sector illustrates the reach and dominance of Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG). Below is a brief comment on each of the six companies:
“The tablet effect is real,” Hewlett-Packard (NYSE:HPQ) CEO Leo Apotheker said last week, but that isn’t news to makers of PC components. On Monday, NPD reported that PC sales grew just 4% year-over-year in the quarter ended July, while Mac sales rose 26% in the same period. The Taiwan-based PC manufacturer Acer just reported the first quarterly loss in the company’s history, and Applied Materials (NASDAQ:AMAT) cited a significant downturn in July PC sales in offering up a gloomy outlook in its post-earnings call Wednesday night.
This news isn’t particularly surprising given the growth in tablets and smartphones. UBS raised its estimates for total tablet sales to 60 million in 2011 and 84.1 million in 2012, with Apple holding a dominant 63% share of the market in both periods. Meanwhile, the market research firm IMS Research estimates that global smartphone sales will rise to 1 billion units by 2016.
These trends have put the pressure on the makers of hard-disk drive and DRAM chips, as evidenced by the year-to-date returns of Seagate (NASDAQ:STX, -27%) and Micron (NASDAQ:MU, -34%). Both of these stocks look cheap, but their shares are likely to remain weak as long as PC sales continue to be affected by tablet and smartphone sales.
For now, the best bet is to avoid stocks whose fortunes are tied to the PC industry due to the competitive pressures posed by smartphones and tablets. Instead, consider stocks that can benefit from the growth in these areas, such as Qualcomm (NASDAQ:QCOM) and ARM Holdings (NASDAQ:ARMH). At a difficult time for the tech sector as a whole, investors should have a laser-like focus on the winners rather than hoping for a miracle in the sector’s most beaten-down names.
Mobile Phone Producers
The downturn in the fortunes of Nokia (NYSE:NOK) and Research in Motion (NASDAQ:RIMM) are well documented. The most important takeaway from the endless discussion about these two stocks is their falling market share. RIMM, for example, has seen its U.S. market share fall from 33% to 12% in the past year. Nokia’s European market share has fallen from 55% to 11% in just two years, and Samsung (PINK:SSNLF) is rapidly closing the gap in the low-end market.
It’s possible that RIMM’s recently announced plan to make its newest products compatible with the Android OS will help stem its market share losses in the year ahead. Still, it is highly unlikely that either stock will embark on a sustainable recovery until there is actual evidence that they are gaining back market share from Apple and Google. Even with their exceptionally low valuations, neither stock should be considered a buy until — and if — this occurs.
Hewlett-Packard appears to be an attractive value here, but what else is new? Its P/E has been in the single digits for more than a year. The company, which last week announced it is spinning off its PC business and mothballing its TouchPad, is now embarking on an ambitious path to refocus its business on the services side.
To be a buyer here, you have to have faith that the company is on the right path, will execute the transition effectively and will be able to compete effectively against IBM. Not least, it will have to accomplish all of this under adverse economic conditions. Keep in mind, this is the same company that in 2010 bought Palm for $1.2 billion largely for its operating system WebOS, only to throw in the towel a year later rather than compete against Apple’s iOS and Google’s Android.
Perhaps someday HP will be a buy as a turnaround story, but there needs to be hard evidence that the company is gaining traction before its valuation moves back into the double digits. Apotheker himself termed the transition process a “multi-quarter journey.” Based on the company’s recent track record, investors can be forgiven for not wanting to go along for the ride.
Shares of Yahoo (NASDAQ:YHOO) often are cited as a value on the basis of a sum-of-the-parts analysis, but at a P/E of 14.95, investors still are being forced to pay up to own a stock that has had its lunch eaten by Google in recent years. Yahoo continues to deliver poor results, and it is showing little of the vision needed to turn its business around.
It’s possible that one day the stock will see a bounce on news of a break-up. However, CEO Carol Bartz’s track record raises the question of whether such a move can be executed quickly and effectively enough to make an investment in Yahoo worth the risk — even with the stock down 29% from its high for the year.
While the outlook is dim for the companies on the victims’ list, these are not stocks that investors should short. The combination of beaten-down expectations, low P/Es and the possibility of takeover activity makes these stocks dangerous to bet against. Still, the possibility of takeover activity is offset by the much greater likelihood that these stocks will remain value traps for some time to come. With so many growing, innovative technology companies now offering compelling values in the wake of the market’s recent sell-off — including, perhaps, Apple and Google themselves — there is no reason to tie up capital in any of the sector’s also-rans.