Tech, tech, who's got the tech: Greenberg on Definitions
Earlier this week Herb Greenberg had an interesting Marketwatch colum on just exactly what is a technology company that's not only worth reading but even more worth thinking about. And then perhaps comparing and contrasting to Fleck's most recent jeremiad where he trys to focus on profits, earnings and margins for real.
Herb borrows and advances the argument that you need to look at R&D spending and gross
margins, which is useful, but only a start and can be more than a bit mis-leading. My argument would be that you need to look at the consequences to that spending in terms of sustainable income and continuos innovation. Which is, btw, really hard work to dig into. But at the end of the day the ability to invest in R&D, translate that into products and sell those products for an above-average profit because you've focused on delivering value is the real set of things to look at. So as you're looking at the excerpts and links below check out the accompanying 3-month chart and ask yourself - is that NDX runup based on sustainable profitable products or not ? Or is it just a momentum play ?
To start with Mr. Greenberg here's what he had to say:
Why Google, Apple, Dell, others may not be what they appear. Herd mentality drives me nuts, especially when it involves "technology stocks" as if one size fits all. It often is a categorization that is as arbitrary and blurry as the line can be between value and growth stocks. That is simply the way Wall Street works, especially when any sector comes into favor, as tech has been in recent months. But that also raises the question: What really is a tech stock? Broadly defined, high-tech is anything having to do with telecommunications, semiconductors or personal computers. But that can be misleading, which is why former hedge-fund manager, tech analyst and all-around out-of-the-box thinker Andy Kessler likes to take it a step further to say that to be considered bona fide tech, a company must spend "some exorbitant amount on research and development" resulting in products that more than pay their own way. The easiest way to figure that out is to look at gross margins and the amount spent on research and development relative to sales. On both counts, the higher the better.
Definitely worth reading but there are several major problems with taking it to far.
Having commented on the column let me quote myself:
A useful set of distinctions and metrics that are also worth kicking around - for one thing if the folks putting money into tech think it's tech then it is; at least from a short- and intermediate-term market view. On the other end of the spectrum the test being proposed here is that relative magnitude of R&D investment in overall spending. By that measure the two really dominant technology industries are Pharma and Aerospace where one should really run two P&Ls. One on the research side and the other on the operations side, linked by the capital asset acquired by the latter from the former. This is really an important distinction - for example the troubles of the Pharma industry are really aging, maturity and failures of it's R&D effectiveness and the need for new approaches. On that path when Boeing or Airbus make a bet on a new plane it's "bet the company time". The B747 gamble almost destroyed BA while the AB380 may destroy Airbus if the hidden assumptions about the structure of the travle market don't work out. If you're wondering what hidden structures those are things an investor should learn.
Back to more traditional companies normally referred to as tech why restrict it to PC's - IBM still dominates the worldwide server market and wraps a lot of very sophisticated software around it to sell it and services around both (btw in the name of digging into details while share of revenue is different share of profit is balanced across the three). Hiding in here are two other distinctions that are really hard to dig out of the normal financials. One is the role of technology; as pointed out above Apple as measured appears to be non-tech, or a hybrid, yet technology innovation is the driving engine of who and what they are. But it's also fair to say that innovation is driven by design-awareness and value focus on the customer.
A 2nd and related distinction is how effective is the R&D component - that is how much usable product and process innovation results from that l.t. investment ? IBM spends enormous sums on R&D which has resulted in great strides in chip technologies and a reputation for innovation yet it hasn't been able to create any new major sources of revenue or growth in over a decade. As a real case in point look at the development investments of the car companies who are extraordinarily large spenders. But what have they to show for it.
So while I applaud the effort and the results I'd also suggest there's a lot more too it. It seems to me the first test is not necessarily the magnitude of R&D - thought that's a nice starting screen - but the fundamental question of how R&D fits into the company's overall strategy and structure. Then one can ask how effective is it in terms of innovation and how effective it is the marketspace and ultimate on revenue and profits. This means really having to dig into the fundamentals - bear in mind, using BA as an example again, the roots of the B787 go back 1-2 decades in terms of design tools, manufacturing processes, materials and so forth.
Unfortunately I don't know any good places to turn to get that kind of information for investors.