Hot Apps Give Hardware a Lift

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Apple provided a telling stat in their last earnings call: It estimated that half of Mac purchasers in their retail stores during the September quarter were first-time buyers. That's a very high percentage, in our view, so we think people are likely to continue to gravitate toward more products outside of the iPod.

Apple's stock is currently trading at 29 times my calendar 2007 estimate, which we believe is reasonable given its market position and growth prospects. Our 12-month target price is $91, based on discounted cash flow and relative price-to-sales analyses.

And which stocks should investors avoid?

We think investors should avoid Creative Technology (CREAF). We downgraded the stock on Oct. 31 from 2 STARS (sell) to 1 STAR (strong sell). It derives 70% of sales from the MP3 player market, and competes with Apple and Microsoft, which will launch its player in mid-November.

Creative is in a difficult market position going against these behemoths with a lot of resources, and it's not making money. We expect the company to lose money in fiscal 2007 (ending in June) and in fiscal 2008 as well. Moreover, it has been reducing its level of R&D spending because of the difficulties, which we view as a major red flag. If you're in this business, we believe you have to keep innovating in order to spur demand for your products. Our 12-month target price on the stock is $5.

HP and Dell report earnings next week—what will you be looking for?

We'll be curious to see Dell's take on how much demand was lost from the battery recall and if it will be able to recapture that during the current quarter. For HP, PC growth will be key—it was the only major vendor that didn't announce a recall, so that should benefit it. HP also has a more diverse revenue base, which includes printers and servers. It will be interesting to see if they took advantage of missteps by competitors, and what the holiday season may hold.