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February 7, 2001

Investors Leery of Tech Growth Promise
By Tom Petruno, The Los Angeles Times

Investors Aren't Buying What Tech Bulls Are Selling ... Weiss comments

LOS ANGELES - Despite the rebound in technology stocks in January, many investors remain suspicious about the industry's earnings-growth potential in 2001 and beyond.

That suspicion showed up in the pullback in many tech stocks in recent days after the January jump, analysts say. The tech-dominated Nasdaq composite index rose 21.28 points, or 0.8%, to 2,664.49 on Tuesday, but its year-to-date gain has been pared to 7.9% from 12.2% at the end of January.

Cisco Systems only added to the concerns Tuesday as it reported quarterly sales and earnings that fell short of expectations -- a rarity for the computer networking giant.

The Cisco news, including the company's warning to analysts to be more conservative in their view of sales growth potential in the next two quarters, points up the risk in tech stocks, even at what may appear to be severely depressed prices, experts say.

Though the share prices -- and the stocks' price-to-earnings ratios -- are far below their peak levels reached last year, most tech issues still carry lofty P/Es relative to the average stock.

Historically, Wall Street has always rewarded the fastest-growing companies with higher stock P/Es.

But if current expectations for tech firms' earnings growth in 2001 turn out to be wildly optimistic, the stocks could be hammered even lower, analysts warn.

Overall, investors are taking a much more conservative approach to tech stock P/Es now than last year. But the declines in valuation are relative.

Cisco shares, after a steep decline, now are priced at 46 times the 78-cents-a-share that analysts on average expect the company to earn in its fiscal year ending in July.

Cisco's stock had sold for a P/E of nearly 190 at its peak last year, so the current P/E is a sharp discount to the levels that prevailed during the tech stock frenzy. But whether 46 is "cheap," analysts note, depends on whether Cisco in fact meets current 2001 earnings estimates -- and whether the estimate for 2002, now 99 cents a share, remains realistic.

Jeffrey Applegate, investment strategist at brokerage Lehman Bros., argued in a note to clients this week that major technology stocks as a group are undervalued given their expected long-term earnings growth rates and the stocks' current P/E ratios.

But judging undervalue and overvalue in the stock market is hardly an exact science. And as many tech shares have demonstrated over the last year, the higher the P/E, the greater a stock's likely plunge if the company disappoints even slightly.

Yesterday, Cisco Chief Executive John Chambers said his company would grow 30% to 50% over the next year. But in doing so, he lowered his expectations of just three months ago. So, if we understand this correctly, Chambers couldn't predict the company's earnings in a three month time span, but he's certain that the company will grow at a 50% clip over the long term?!

That's quite a leap of faith he's asking investors to take - especially when he admits that Cisco probably won't grow at all over the next six months. But Cisco isn't alone; most tech companies are peddling the same manure. They're scrambling to protect their already-ravaged stock prices even though sales have slowed to a crawl and profits have flown out the window. The way the Nasdaq is falling on its face, it's easy to see that more and more investors aren't buying this line of bull.

As much as tech bulls like to hype the future, there's nothing to guarantee that company sales will turn around in the next six months. Far from it. Business confidence has fallen even faster than consumer confidence; companies aren't buying any new computers, software, or any other technology products. Plus, tech companies have built up such huge inventories that they'll need a fire sale to unload their old products. So, even when companies start buying again, profits will still be low.

The majority of tech companies are still outrageously overvalued. We believe that the Nasdaq still has to fall by as much as 50% before getting back to reasonable levels. Finding a reasonably priced tech company is like finding a needle in a haystack. And, chances are, even if you find a company with a low P/E, it will get caught in the wave of selling that is bound to wash over the tech sector.

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