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Technology and Consumer Staples Investing Themes 2008: A Tale of Two Halves - Part3

Companies / Sector Analysis Jan 25, 2008 - 11:00 AM GMT

By: Hans_Wagner

Companies

Best Financial Markets Analysis ArticleThe beginning of a new year is a good time to make a new assessment of the important investment drivers and themes for the year. If you want to beat the market it is important to understand what is driving the markets and where are the best sectors to find good opportunities. By identifying these factors you will have a solid framework to assess the impact market movements and news events on your investment strategy. This is the third of a five part series on the outlook for the 2008 markets. The first part discussed the key drivers ending with a mention of what sectors will benefit and those that will be hurt. Part 2 reviewed the outlook for the energy and financials sectors.


This part discusses the Technology and Consumer Staples sectors. For those interested in making money in this market you might want to read Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance) by Vitaliy Katsenelson. The core of Katsenelson's strategy is to break down into three key pieces what you need to look at when analyzing a company: Q uality, V aluation, and G rowth (QVG).

Technology

Storage will continue to be in demand as IT managers try to keep up with the growing demand. According to Storage Technology News the top Storage priorities are:

2008 Storage Priorities
Tasks Among Top 3 Priorities for 2008

Backup
Adding capacity
Archiving
DR
Data deduplication
Replication
Virtualization

39.1%
22.2%
20.7%
18.8%
15.7%
14.9%
13.4%

*based on 261 valid survey responses

To help offset the costs of storage users are looking more closely at virtualization. According to SearchStorage.com only 12% users are using storage virtualization, while 55% plan to either deploy or evaluate virtualization in 2008. This should be good news for storage companies like EMC and VMWare, of which EMC still owns 86%.

Semiconductors remain at the heart of technology; however, they no longer are the primary drivers of growth. As a result investors should be careful when considering this sub-sector. These companies require significant capital investment to maintain their technological lead, yet the returns are not commiserate with the risk. Also, with the U.S. economy slowing it will slow demand for consumer products which will also hurt the sales of the semi manufacturers. We might see better results in the second half of 2008 as the U.S. economy recovers. However, investors should do their homework before making a commitment.

The semiconductor equipment manufacturers will experience lower sales in 2008 as the semi manufacturers spend less on new equipment. I do not look for this sub-sector to turn around until the semi companies have achieved higher sales so they can justify the expenditures. Investors should avoid this sub-sector in 2008.

Computer hardware manufacturers should do well in 2008 as companies continue to upgrade their equipment that can use Microsoft's Vista. Apple will continue to take market share as consumers and even some companies buy MACs, especially laptops that are multimedia capable. Both companies and consumers will be looking for PCs that are capable of handling quality video in addition to normal computing needs. Hewlett-Packard should continue to do well, especially since they have such a strong international presence. Dell, while still lagging, could be making a significant turn around, making them a good potential investment for the second half of 2008. Dell still is too dependent on business from the U.S., which is hurting them as the economy slows. Then there is IBM, who continues to do well in all aspects and has a big share buyback program in place.

Wireless will grow in importance as consumers migrate to higher speed networks and use their devices from video as well as voice and texting. Nokia will continue to dominate in the phone category with Research in Motion (RIMM) doing well in the smart phone category. Apple, with the iPhone, has created a new category of easier to use wireless devices capable of voice, texting, email, music web browsing and video. Other manufacturers will be trying to play catch-up. Look for growth in the emerging economies as the U.S. and Europe experience slowing economies. Oh, yeah, Palm might make it if their new investors and management can generate new and exciting products, otherwise it will disappear.

Software remains the best place to be in the technology sector. It provides the special features that customers demand and is the key to the blending together voice, data and video. The growing capabilities of mobile devices are also driving the demand for software. The current upgrade cycle by corporations will add to the demand for software from operating systems to applications.

Microsoft should continue to benefit as they are well positioned in many markets from corporations, consumers, gamers and mobile device users. Oracle (ORCL) should continue to do well as they consolidate their acquisitions and benefit from their strong recurring revenue base and maintenance revenues and continue their domination of the corporate application software world. The current difficulties of the financial sector will have some negative affect on the software industry, however, I believe the banks still must acquire the software to remain competitive and comply with regulatory demands. Adobe Systems (ADBE) could be interesting as it seems to be growing revenues from their new products and market penetration.

Overall technology is likely to experience a difficult year, but in the end it should outperform the S&P 500.

Consumer Staples is an industry that sells the necessities that consumers continue to buy even during a recession. As a result this sector is considered "defensive" and generally performs well in a slowing economy. In addition many companies in this industry are increasing their presence to global markets where new demand for their products should help this sector to perform well both during the slow down and later during the up swing in the U.S. economy. Also, the dividend yield remains above its historical average.

This exposure to the global growth story has raised the valuations of this sector above historical averages. So this may limit the growth one normally would expect. The companies that perform best during a slowing economy are those that sell tobacco, household products, and alcoholic beverages.

Some of the companies that should do well in this sector are Coca-Cola (KO), PepsiCo (PEP), P&G (PG), and Colgate Palmolive (CL). Investors could also just buy the Consumer Staples ETF Select Sector SPDR-Consumer Staples ( XLP ).

Coca-Cola is benefiting from the global demand for its products. In the third quarter Coke was able to increase prices helping to grow net revenue by 19 percent on worldwide unit case volume growth of 6 percent. International unit case volume was up by 8 percent reflecting their growing international presence.

In the third quarter PepsiCo's net revenue increased 11%, while PepsiCo International (PI) revenue grew 22%, and profits increased 19% on strong snacks and beverage growth. Pepsi also has a significant snack food business (Frito-Lay) and they own Quaker Foods. These products are also receiving acceptance globally and will help the company to grow its revenues.

Procter & Gamble manufactures a wide range of consumer goods sold throughout the United States and the world. Some of their products include Gillette, Duracell, Braun, Oral-B, Folgers Coffee, Old Spice, Max Factor, Tide, Crest toothpaste, Downy fabric softener and Pampers. As an indication of P&G's international exposure, there are 12 countries with over $1 billion in sales per year.

Colgate Palmolive manufactures household, health care and personal products. Colgate has operations in 200 countries, but it is publicly listed in only two, the United States and India. Some of the Colgate brands include Softsoap, Speed Stick, Irish Spring, Ajax, Palmolive, Colgate toothpaste and toothbrushes.

Normally during an economic slow down large capitalized companies do better than small capitalized firms. That is why I selected these large companies as initial candidates for the ones to consider. One of the problems companies in this sector will encounter is the rising cost of commodities. This will pressure margins in the latter half of 2008.

Consumer staples companies are well suited for investors who seeConsumer Staplesk safety from the volatility associated with a bear market and an economy that is slowing down.

The Bottom Line

Technology was one of the better performing sectors in 2007. In 2008 it will face a much more difficult time as the U.S. economy slows. Companies that have significant international exposure will do better as they benefit from the growth in these economies. While technology will perform worse than it did in 2007, it will still out perform the S&P 500.

Consumer staples will have a good first half of 2008 and the U.S. economy either slows down or goes into a recession. As a result this sector will do better than the S&P 500 in the first half of 2008. Once investors believe the low in the economy is near, I expect the consumer staples sector to under perform the S&P 500. This will most likely take place in the second half of 2008.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Hans Wagner Archive

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