Have Nasdaq's Tech Giants Flamed Out? Cisco, Intel, Microsoft, and Oracle used to be the tech stocks you would gladly buy for your mom. Maybe it's time to rethink that notion.
By Nelson D. Schwartz and Erick Schonfeld

(FORTUNE Magazine) – For most of the 1990s, a bet on one of the Nasdaq's four horsemen was as close to a sure thing as you could find on Wall Street. Buy any of these tech giants--Cisco, Intel, Microsoft, or Oracle--and you could look forward to quarter after quarter of capital gains with a confidence approaching that of a bondholder clipping coupons.

And wow, did those gains ever multiply. Take Oracle, the least widely held of the Big Four. Trading at just over $4 at the end of 1992 (all prices are split adjusted), the maker of database software rose to $8.50 by the end of 1993 and kept right on soaring through 1994, even though the broader market was flat that year. By the end of 1996, Oracle was near $30 and still headed upward. Intel did even better, rising from around $10 a share in 1992 to more than $100 a share last summer.

As they ballooned, the Big Four became not only the chief symbols of the bull market but also among the most popular ways to participate in it. Intel is now the fifth most widely held stock among Merrill Lynch's retail investors, just behind venerable blue chips like Merck and GE. More than one in four equity mutual funds tracked by Morningstar own the giant chipmaker, and more than one in five hold Microsoft or Cisco. Even holders of index funds are saddled up with the four horsemen, whether they know it or not, since the Nasdaq giants compose nearly 5% of the S&P 500's market capitalization. In other words, as long as these stocks kept climbing, millions of investors kept getting wealthier.

But starting this summer, the stocks stopped climbing. Intel is now off more than 30% from its late-August high. Oracle is down 50%, to $21, with much of the damage having come in a single stomach-churning drop in December, following word that second-quarter earnings would miss Wall Street estimates. Microsoft is down 15% from its summer high. Only Cisco, trading just four points below its all-time peak of 60, has been able to hold its own.

What's gone wrong? For starters, the slowdown in Asia suddenly made the Big Four's global presence a liability rather than an asset in many investors' minds. In addition, developments specific to their industries have confronted each of the four with challenges that may considerably alter the way investors perceive them in the future.

Clearly, then, these market leaders are at a crossroads, and it's worth figuring out what's in store for them between now and the year 2000. The answer matters whether or not you own them. After all, they've carried more than their share of the bull market of the 1990s on their well-capitalized backs; if they falter, there's a good chance the broader market could be right behind them.

No one, of course, can say for sure what the future holds in a field as fast moving as high tech. But here is a look at today's best thinking on tech's four biggest names as they enter what may be their most difficult stretch in a decade.

MICROSOFT

It's pretty obvious why some people think the easy money has already been made in Microsoft. For starters, the software giant is the focus of an aggressive probe by the Department of Justice, a troubling enough event that Microsoft's high-handed tactics have only made worse (see "Microsoft's Capital Offense"). And it doesn't help that Bill Gates goes into his wrestling match with Janet Reno burdened with a P/E over 35, nearly double the multiple of the S&P 500. That leaves little room for error at a time when earnings growth is slowing (albeit from warp speed to a merely blistering pace). Lehman Brothers' Michael Stanek is maintaining a strong buy on the stock, but he concedes, "Microsoft isn't a company that will grow by 80% annually anymore." Instead, Stanek expects the stock to settle into a long-term growth rate of 25% to 30%.

But that's good enough to make MSFT a buy in our opinion. Few, if any, companies have so clear a path to double-digit profit growth well into the next century. Even if Microsoft's income growth rate isn't what it used to be, says Stanek, "profits are still incredibly secure. It's very hard for me to imagine this company's earnings coming up short over the next year or two."

What makes Microsoft's growth picture so clear? First, "they dominate every category they're in," says Stanek. Plus, licensing fees on such ubiquitous Microsoft products as the Windows 95 operating system and the Microsoft Office suite of business applications have smoothed out some of the peaks and valleys usually associated with the software industry. In a market where techs implode with terrifying regularity, investors will continue to pay a premium for this kind of dependability.

What's more, Microsoft is on the verge of delivering a series of new blockbusters. The fireworks are scheduled to begin in late spring with the release of the Windows 98 operating system for desktop computers, followed late this year or early next year by shipment of Windows NT 5.0 for corporate networks. The buildup continues into 1999 with the release of updated versions of Microsoft Office and the SQL Server database. "Microsoft stock tends to move up in front of the release of major new software programs," says analyst Michael Kwatinetz of Deutsche Morgan Grenfell. "And NT 5.0 is the most important release since Windows 3.0 in 1990. It's huge." Basically, NT creates a single, easy-to-use standard for enterprise computing--that is, systems based on big mainframes, workstations, and servers rather than individual PCs. Corporations relying on these high-capacity computers no longer want to cope with a babel of incompatible operating systems.

Previous versions of Windows NT have already devoured 50% of the $12 billion workstation market, and Kwatinetz thinks the new version could help the company grab most of that remaining 50%. But the truly stunning potential for version 5.0 resides in the $60 billion to $80 billion market for heavy-duty enterprise software, in which Microsoft controls only about 5%. Gaining a 20% share could double Microsoft's $14 billion revenue base. "Their share of this market is growing rapidly," Kwatinetz adds. "Even if the rest of Microsoft's business slowed considerably, this market alone could enable it to grow 20% or more annually for at least five years."

In the meantime, Windows 95, which some analysts are already calling a dinosaur, still grows at a comfortable annual rate of 25%. Even Microsoft's lesser-known products continue to generate huge returns. Sales of Microsoft Exchange, essentially a sophisticated E-mail system for big networks, jumped by 300% in 1997.

But what about that Justice Department probe? Forget the $1-million-a-day fine that feds threatened to levy if Microsoft refuses to unbundle its Internet browser and Windows 95 operating system. Microsoft makes $1 million in an hour. The worst case would be if the dispute over the browser boils over into the kind of protracted antitrust battle that engulfed IBM in the 1970s. It's possible if Microsoft truly overplays its hand, but it's more likely the company will reach a compromise with Justice. The possible penalty, while it could be a large number, will barely register on the Microsoft juggernaut. Says Goldman Sachs analyst Rick Sherlund, an influential Microsoft follower: "It's a sideshow. It doesn't matter to earnings." And in the long run, it's earnings that determine stock prices.

All right, then, what about the slowdown in Asia? Again, analysts say it's no worry: The drag on earnings posed by the Pacific Rim will be overwhelmed by any positive response to the upgrade of Windows NT and the other new products, especially over the next 12 to 24 months.

Yes, the company's steep P/E should give you pause. But for a moment stop thinking about Microsoft as another tech company, and think of it as a unique, high-margin brand not unlike Coca-Cola. The only difference is, there's no Pepsi in Microsoft's world. Once the dispute with the government is settled, you have clear sailing to consumer staple-like earnings reliability with 46% operating margins. Stanek, for one, predicts MSFT shares, now at $130, could hit $160 by summer and $200 by the end of 1998. DMG's Kwatinetz is also bullish. "When a company is as well run as Microsoft," he says, "they just find new opportunities."

CISCO

It used to be that no information officer ever got fired for buying IBM equipment. Today, that distinction--along with its attendant competitive advantages--belongs to Cisco Systems, whose routers and switches serve as the ganglia that connect computers together in networks. According to BancAmerica Robertson Stephens, Cisco's $1.9 billion in revenues last quarter accounted for 46% of the entire networking industry's sales, and its net income of $416 million (before a pretax $127 million acquisition-related charge) made up 54% of industry profits. Because these networks are so complex and expensive to build, corporations are extremely loath to change an established vendor that provides proven, efficient solutions. And that, in turn, gives Cisco's market leadership an air of impregnability. Says Richard Wallman, manager of the Dreyfus Technology Growth Fund: "Cisco is so far ahead, I don't see how any other company can catch up."

Cisco customers have every reason to be loyal. The company has the deepest product line of any networking-equipment supplier, making it the closest thing to a one-stop vendor in the business. And since Cisco equipment works best when networked with other Cisco gear, corporate information technology officers can simplify their lives and cut costs by sticking with Cisco. The company's hold on its market is so firm that it doesn't need to worry about losing share if it's not the first to bring new technology to market. "It's not a technology game anymore," says Wallman. "It's, 'Will this vendor still be around in a few years?'"

Cisco's growth seems assured by the continual need to upgrade the bandwidth of computer networks--that is, their information-bearing capacity--to accommodate demanding new applications and ever more numerous users. Zona Research of Redwood City, Calif., estimates that by 2000, the 50 million computers connected to the Internet will quadruple. The only way to carry that much traffic is to beef up networks with new routers and switches--and more often than not, they will be Cisco products.

The question any Cisco investor needs to ask, then, is whether the express-train expansion of computer networking can be derailed anytime soon. Could the Asian turmoil do it? After all, a short-term slowing in orders from abroad was one factor in a 38% swoon in the stock last spring. Cisco makes about 12% of its sales in the Pacific Rim, but as fund manager Michael Murphy, author of the California Technology Stock Letter, points out, Asian economies need to invest in their information infrastructure as a matter of survival. "How do you think those countries are going to get out of this mess?" he asks rhetorically. "Sharply reduce capital spending on technology and sell tennis shoes? I doubt it."

Longer term there is a risk that Cisco's business, still dependent for about half its revenues on routers (the machines that dispatch information packets along a data network), could be supplanted by a new technology. But it's doubtful that Cisco's management would let that happen. In 1994, for example, it was said that switches would replace routers in local area networks (those that link a single building or campus). Cisco responded by buying up enough LAN switchmakers to dominate that market as well. And it continues to look ahead. In December, for example, it announced a $160 million deal to acquire LightSpeed International, a company specializing in software for sending voice transmissions over data networks--an area that will be a future engine of growth for the industry.

At $55.50, the stock is up 80% from its low last April and is trading at 28 times BT Alex. Brown analyst Jim Wade's 1998 earnings estimate, pretty much in line with his 30% expected earnings growth rate over the next five years. Although the stock is certainly not cheap, DMG analyst Noel Lindsay points out that Cisco's growth potential is something you can count on. "Given that the overall networking market will grow at a healthy pace for a long time to come," he says, "anyone serious about investing in technology simply must make Cisco a core holding."

INTEL

Even more than Microsoft, Intel--whose microprocessors run 90% of all desktop computers on the planet--has become the symbol of technology's acceptance as a blue-chip investment. That very popularity, however, has made the 30% drop in Intel shares during the past six months all the more painful.

What happened? For starters, the unexpected boom in sales of sub-$1,000 PCs, along with excess chip inventory at PC makers, has put a viselike hold on Intel's 58% profit margins. The Asian meltdown has also hurt, exacerbating fears about slowing demand for PCs.

These and other factors have made longtime Intel bulls like Merrill Lynch's Tom Kurlak unusually cautious about Intel right now. Kurlak first warned investors in August about the danger posed by falling chip prices and big inventories. And despite the big drop, he isn't advising investors to jump back in. "The fundamental bottom in the stock and the group hasn't been reached," says Kurlak. "It's going to work its way a little lower--not dramatically lower, maybe into the mid-60s."

Right now, Intel is facing unusually sharp price competition from rivals like Cyrix and AMD, which make clones of Intel's popular Pentium chip. The clones cost less than comparable Intel chips, and they are perfectly adequate for the sub-$1,000 computers that have become the fastest-selling items on computer retailers' shelves.

This challenge threatens Intel's overwhelming share of the microprocessor market, and it has forced the company to cut prices on its newest microprocessors more quickly than many observers thought would be necessary. In addition, the expected shift from Pentium-based computers to faster, more expensive Pentium II machines has occurred more slowly than Intel had hoped, further crimping profits. Those factors explain how Intel could ship 20% more chips in the most recent quarter, by Kurlak's estimates, and still experience no revenue growth. Kurlak doesn't expect the pressure to ease up, at least in the first half of 1998.

Once you look past midyear, though, the picture gets a lot brighter. Analyst Mark Edelstone of Morgan Stanley notes that as production ramps up, the transition to the more profitable Pentium II should build steam, adding that "by mid-1998, Intel should be in the sweet spot of the Pentium II cycle." What's more, Intel is scheduled to release a slew of new, higher-margin Pentium models in coming months, including superfast 0.25-micron chips (the number is a measure of the microscopic circuitry on the chip). The full impact of those new products won't be reflected in Intel's results for at least six months, Edelstone says, but Intel's stock should start recovering from its depressed levels by late spring.

What's more, Wall Street hasn't fully factored in the long-range impact of the revolutionary new Merced chip, which Intel should start shipping in 1999. Based on a different architecture from the X86 chip line that has been Intel's mainstay during the past two decades, the powerful Merced is aimed at high-end servers and workstations. Intel now has only a small piece of that market, which is dominated by proprietary chips from companies like Sun, Hewlett-Packard, and IBM. Because of Merced's added power and potentially lower cost, however, Intel could singlehandedly grab a much bigger share of that high-margin niche. In addition, says analyst Michael Kwatinetz of Deutsche Morgan Grenfell, the brawnier servers now in development will probably need several times more chips than current models. "By 2000, the number of servers is expected to triple," says Kwatinetz. "But I expect the number of processors going into them to increase sevenfold. That means Merced could be a $5 billion to $10 billion opportunity for Intel by 2000."

One short-term caveat, however. Intel is set to announce fourth-quarter results just as this issue hits newsstands, and it's anyone's guess whether the company will match the consensus earnings estimate of 90 cents. But what's more important is the guidance the company will give investors for the first quarter of 1998 in the conference call that will follow the earnings report, says Bear Stearns' Andrew Neff. Besides profit margins, Wall Street will be anxious to find out how quickly Pentium II chips are catching on. If the Pentium II transition is on track, Intel shares could get a boost. If the switchover appears to be bogged down, the stock could suffer.

For long-term investors, though, these problems aren't too much of a worry, especially because Intel is the cheapest of the Big Four. It's trading at 18 times earnings, a discount to both its own 20% growth rate as well the P/E of the typical S&P 500 stock. It's not often that you can pick up a brand-name company with 90% market share for a below-average multiple. Plus, Intel's new product line, especially Merced, will start drawing more notice over the next few months. Already, many money managers are secretly hoping Intel falls below $70 so they can hop on for the long ride back up. Edelstone, who rates Intel an outperform even at its recent $72.75, figures its shares could be back up at $100 by year-end.

ORACLE

Oracle's earnings disappointment and ensuing plunge in early December were more than just signs of moderating growth in the tech sector. They made for a shocking turn of events for a company that up to then had rewarded shareholders generously and unfailingly. In fact, Oracle had finished sharply higher each year since 1992, a feat unmatched by the rest of the Big Four. Now, though, analysts make a persuasive case that the database management company is finished as a stock market superstar.

It wasn't just the earnings shortfall that triggered the December debacle. It was the even more alarming single-digit growth in revenues in Oracle's core business of database management software. For example, Goldman's Rick Sherlund was expecting demand for Oracle's applications software to be up by 40%. Instead, sales grew by an anemic 7%. Tellingly, in a gloomy conference call following the announcement, Oracle execs didn't predict a quick turnaround, the usual custom when companies disappoint the Street.

More than six weeks have passed since the bad news, and Oracle has fallen another 10%, but Sherlund is still pessimistic. "The outlook is very clouded," he says. "Even if the company has a good quarter, investors will still be skeptical."

Could Oracle's problems actually represent a buying opportunity, not unlike that surrounding Intel's Pentium bug in 1994? (At that time a minor flaw discovered in the Pentium briefly caused the stock to drop by 10%.) Probably not. Oracle faces a meaningful slowdown in its core business, rather than a single, easy-to-fix problem like Intel's Pentium scare. Simply put, there are strong signs that Oracle's key markets are saturated right now. Customers can manage their data perfectly well with the programs they have and are putting off big, new purchases. Before October the company had been looking to the relatively untapped markets of Asia for future growth. That hope, obviously, has been put on indefinite hold.

Then there's the issue of new competition from a small outfit known as Microsoft. Gates and Co. are readying an updated version of their own database product, SQL Server, for release in 1999. That's the last thing Oracle needs. "This is more of a problem for 1999 than 1998, but SQL will weigh heavily on Oracle stock," predicts analyst Melissa Eisenstat of CIBC Oppenheimer. "Because when Microsoft gets someone in its cross hairs, watch out."

That's not to say that Oracle can't rise 20% or 30% from its currently hard-hit level. The company still has a formidable brand name and is gaining market share from even more battered rivals like Sybase and Informix. What could push Oracle higher? According to Eisenstat, the upcoming release of its new Version 11 applications product this spring is likely to give the stock a bit of a boost. Even so, there are many places to put your money that are likely to be more rewarding. "The stock has maybe two to three points of downside risk and about seven points of upside potential," Eisenstat says. "With all the uncertainty about the company's future growth, that isn't so compelling."

INSIDE: The half-life of growth, page 167... In pursuit of tax efficiency, page 170... Bond market heaven, page 173... Pick a great coat, page 177