Happy New Year for Channel Stocks

Solutions providers, still savoring last year’s market rally, head into 2004 with continued momentum on Wall Street.

For the week ended Jan. 2, 2004, our Ziff Davis Channel Zone Stock Index rose 2.61 percent to 1116.49. Winners beat decliners last week by the overwhelming margin of 5 to 1. Big winners include Sapient Corp. (SAPE, +18.88 percent), Manchester Technologies Inc. (MANC, +14.29 percent), Covansys Corp. (CVNS, +9.58 percent), Cognizant Technology Solutions Corp. (CTSH, +7.66 percent) and MPS Group Inc. (7.22 percent). The only significant decliners were Accenture Ltd. (ACN, -3.84 percent) and IBM Corp. (IBM, -1.45 percent).

Overall, our index is up a healthy 11 percent since we launched it in October 2003. The rally is easily explained: U.S. businesses will increase their IT spending around 4 percent this year, predicts Forrester Research Inc. of Cambridge, Mass. That’s good news for solutions providers, but it’s unclear how long their stocks can continue to rally.

Shares in many solutions providers have doubled—and even tripled—since early 2003. Using basic financial metrics, shares in many solutions providers appear overpriced. For instance, Covansys Corp.’s stock trades at a price-to-earnings (PE) multiple of 183.3, making it six times more expensive than Microsoft Corp. shares, which have a 30.2 PE, according to Yahoo Finance. Nine stocks in our 30-member index have PEs above 40, which means solutions providers need to grow their earnings very rapidly in order to maintain—and potentially increase—their current stock prices.

Irrational Exuberance Returns?

At least for last week, investors weren’t worried about lofty PE multiples. Sapient, the digital consulting firm, continued a renaissance that pushed shares to $5.73—nearly four times higher than a 52-week low of $1.52. Sapient is expected to announce break-even results (or perhaps a small quarterly profit) on Jan. 22, according to Earningswhispers.com.

Similarly, Manchester Technologies, which has delivered small profits in its last two quarters, is expected to remain in the black when it announces 4Q results on March 11. The upbeat forecast has pushed Manchester shares within 25 cents of their 52-week high.

Meanwhile, Bear Stearns spooked IBM investors last week. An analyst from the financial services firm predicted that IBM may miss its 4Q target for new IT services deals by up to $2 billion. The report pushed IBM shares down 1.45 percent on the week. IBM, which will disclose 4Q results later this month. IBM did not comment directly on the Bear Stearns report, but did manage to announce a 10-year IT services deal with retail giant Target Corp. Financial terms of that relationship were not disclosed.

Shares in Accenture also fell last week, though the decline wasn’t driven by any particular news event. Accenture is scheduled to announce quarterly results on Jan. 13.

About this Column: The Ziff Davis Channel Zone Stock Index tracks 30 channel-related stocks on a weekly basis. We don’t recommend buys, sells or holds. Rather, the index seeks to measure the channel’s financial health. We launched the index on Oct. 24, 2003 with a value of 1000. Each stock in the index is equally weighted. For example, if one stock rises 5 percent and another falls 4 percent, the net result is a 1 percent gain.

Joseph C. Panettieri (joe_pan5@yahoo.com) has covered Silicon Valley since 1992. He is editorial director of the New York Institute of Technology .