Hot Apps Give Hardware a Lift

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With Leopard, it's the same scenario—you'll probably have demand that would have occurred in December spill over into the first quarter as people wait to get the new version. Another important aspect with Apple's Leopard is a toggle switch that will allow you to switch between that system and Microsoft's operating system. We believe this may alleviate some of the normal apprehension with learning a new operating system, and therefore is a big plus for Apple.

Pricing pressures have been plaguing PC makers for years—what are they doing to offset this?

I think the big thing is cost reduction—that involves layoffs, outsourcing to electronic manufacturing services companies, and moving to low-cost manufacturing countries—that's where the focus has been as margins have been squeezed. Sometimes PC makers come out with a new product with an extra feature or two that allows them to charge a premium price, and they're selling monitors or printers or other peripherals to go with PCs to help make up for some of the difference.

I think we'll continue to see lower prices for PCs. Logitech (LOGI; ranked 3 STARS, hold), a maker of wireless mice and keyboards, recently cited a study that said that PCs may be free someday and the companies would generate revenue from peripherals.

Are there any other challenges that hardware makers face?

Besides pricing, I'd say competition is ever-present, so execution is critical. HP (HPQ; ranked 3 STARS, hold) has been successful in this regard, and as a result, recently eclipsed Dell (DELL; ranked 3 STARS, hold) as the No. 1 provider of PCs.

Also, slower economic growth would be more challenging for PC makers, which is what S&P is forecasting for next year. We think a lot of that is likely to be outweighed by the new operating systems that are coming out, but a slower economy will definitely have a negative impact.

Which stocks do you like in the group?

I'm positive about three stocks. I upgraded IBM on Nov. 7 to a strong buy from buy. Part of the thesis lies in our view that IBM tends to be a solid defensive technology play, which would be more attractive given the less robust GDP outlook. The company generates over half of its revenue from services, which fits in with a more defensive posture. We believe that companies are more likely to continue spending on consulting and services projects, given that many are cost-reduction related, regardless of what's happening in the economy.

Apple is ranked 4 STARS (buy), in part due to new products coming out next year. There's Leopard and iTV—and there are also rumors about an iPhone coming out in the first quarter. I also expect it to continue to gain share in the PC market.

The other name I'm positive on is EMC. It has the No. 1 market share position in the external disk storage systems market and we believe spending on data storage products and services will remain a high priority over the next 12 months. We have a 4-STARS (buy) opinion on EMC shares.

The company has an advantageous financial structure, generating a significant amount of free cash flow; it produced $1.6 billion last year in free cash flow and just under $1 billion in the first nine months of this year. Also, it has undertaken a significant number of share repurchases—it is targeting $3 billion worth of stock buybacks this year.

What's your outlook for Apple and valuation of the stock?

We believe it is benefiting from the halo effect. The concept is that when you buy one product from Apple, then you may be more apt to purchase others. For example, people who have bought iPods might check out a Mac instead of a PC from Dell or HP.