Taking Stock: Dog Days Leave Investors Sweating

Technology investors have had a rough summer, and so have I. Maybe I should have gone to the Hamptons for the summer, but living in San Francisco makes the travel unappealing. Instead, I'm listening to more quarterly earnings reports.

Everyone talks about the big-capitalization stocks such as Cisco Systems, Intel, and Microsoft, but the technology landscape consists of much more than just those big companies. So to stir things up a bit, let's go over some middle-tier names in security.

I've mentioned Check Point Software Technologies, a leader in business firewall and security software, in the past. The company reported second-quarter 2004 results of $126.9 million in revenue and earnings per share of 25 cents. License revenue was $67.9 million. Despite slightly lower operating margins for the quarter of 54% and conservative EPS estimates for the third quarter, I believe the company should still earn about $1.03 and $1.13 (Wall Street consensus) per share for 2004 and 2005, respectively. Cash and investments on the balance sheet are a healthy $1.6 billion. Despite the fundamentals, the stock price dropped from $20.74 to $18.49 upon the earnings news, a fall of roughly 10.8%. The price decline since June 30 has been 31.5%. In my opinion, the risk/reward trade-off is starting to swing in the favor of long-term investors.

Another familiar name in security is Entrust, a provider of authentication software and secure messaging. It shared no revenue guidance for next quarter or for the fiscal year, saying it couldn't put a good estimate on future sales. Entrust's quarterly revenue of $19.5 million represented a decline of 13% year over year top line and -15% quarter over quarter. In my opinion, the stock may be cheap if the price goes much lower than its current $2.69, as the company has $1.64 per share in cash and equivalents. Like many smaller software companies, it continues to use service and maintenance fees (76% of revenue this quarter) to stay in business, because new license revenue seems to be scarce. Wall Street EPS consensus is a loss of 3 cents for 2004, but goes to a gain of 6 cents for 2005.

SonicWall, a supplier of security appliances for the small-office/home-office market, missed its earnings estimate by a penny. Given that the EPS estimate was 3 cents and it came in at 2 cents, it doesn't seem worth getting too excited over. For small-capitalization tech companies, the markets have been merciless when they disappoint. SonicWall went from $8.10 per share two days before it reported to $6.12 after the earnings report--a drop of 24% in two days, but some investors may have gotten some earlier insight about the bad news because the stock dropped more than 8% the day before the earnings release. Wall Street EPS consensus is still 13 cents for 2004 and 21 cents for 2005.

None of the numbers seem that horrible to me, but a lot of trading activity is causing pricing volatility. I think it's time to use up the rest of your summer vacation and come back Labor Day in the hopes that the market will behave a little more rationally.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at [email protected]. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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