Hot Apps Give Hardware a Lift

New operating systems from Microsoft and Apple, plus healthy demand for laptops, should help drive sales for computer hardware makers

Rising sales of laptops and new operating systems from Microsoft (MSFT) and Apple (AAPL) should help drive sales at computer hardware makers in the coming months, says Richard Stice, who follows the group for Standard & Poor's Equity Research.

Computer hardware stocks have rallied recently, thanks to a relatively strong earnings season and improved investor sentiment for technology stocks. The S&P Computer Hardware index has jumped 16.5% in the last 13 weeks (through Nov. 3), outpacing the 6.6% gain in the S&P 500.

Stice has a neutral outlook for hardware companies overall, mainly because of continuing pricing pressures, stiff competition, tough comparisons for unit growth, and an expected economic slowdown in 2007. However, he likes three stocks: IBM (IBM), Apple, and EMC (EMC).

BusinessWeek.com's Karyn McCormack spoke with Stice on Nov. 7 about the trends he sees for hardware and his favorite stocks. Edited excerpts from their conversation follow.

Note: Richard Stice is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies on which he writes research. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed.

What will drive hardware sales in the coming year?

For the coming year, I expect hardware sales to remain relatively stable. For PCs, I'm looking for a low double-digit percentage increase in units.

We believe a key driver is the migration from desktops to laptops. One reason for this is the mobility factor, which allows you to use a laptop while traveling and in different parts of your home (see BusinessWeek.com, 11/6/06, "Building a Better Computer"). And now, with WiFi hot spots popping up in additional locations, it's more convenient than ever to own a laptop. Also, prices have come down while functionality has improved, so it's to the point that you're not seeing much of a difference between laptop and desktop performance.

What are the hot products or applications that you think could boost sales?

The big application is Microsoft's Vista operating system, which will have two versions. The corporate version is expected to be released sometime this quarter, and the consumer version is coming out in January.

Apple's new operating system is called Leopard—it's coming out sometime in the first quarter of 2007. Those will be the two applications to watch, with Vista in particular since it comprises the vast majority of the market.

The question is, when are consumers going to make the decision to purchase a PC. If they do it now, Microsoft has deals with PC makers that provide a free rebate for the Vista upgrade once it's released. Therefore, we believe seasonal demand may not be as negatively impacted as previously thought. Otherwise, we think consumers will wait until after the operating system comes out in January.

Will the rebates keep the sales up? I think probably not. I think you'll see some demand spill over to the first quarter that wouldn't normally be there. The other question would be what sort of adoption rate will we see with Vista. According to researcher IDC, 68% of PC shipments will have Vista installed by the end of 2007.