It’s Time to Sell These 2 Tech Stocks

02/15/2012 12:36 pm EST


The market has had a torrid romance with tech stocks recently, but this is precisely the time to lighten up on shares that have run a good race and lower your risk, writes Paul McWilliams of Next Inning Technology Research.

Hittite (HITT)
HITT trades with fairly high volatility, but unless there is a fundamental driver for a breakout, it tends to stay within a fairly well-defined channel. At present, HITT is trading towards the high side of its channel.

While I think soft infrastructure spending and the likelihood of that extending through the first quarter could keep a lid on the price, I think full-year earnings estimates are too low right now.

Once we see infrastructure spending pick up (particularly for microwave backhaul), the price of HITT will move back into the $60s where it was trading a year or so ago. In other words, I think there is a fundamental event on the horizon that will drive HITT to break out to the high side of its recent channel.

However, what is much less clear is how HITT will present itself, and how it sees this fundamental change in the demand environment unfolding. In other words, HITT might choose to keep expectations in check and only focus on the near-term (that other companies have suggested will remain soft), or it might choose to look past the near-term to when most companies think the demand environment will improve.

If the former, we’ll probably see the price of HITT dip back towards the lower side of its trading channel. But if the latter, there is a chance we could see HITT break out of the top side of the channel, and with that create a new and higher trading channel.

As I see it, when considering HITT’s balance sheet is worth roughly $13 per share, if demand for wireless infrastructure picks upâ€"like I think it will this yearâ€"the price of HITT could easily move into the range of $62 to $68. This suggests an upside of about 15% to 20%.

However, if HITT elects to keep expectations in check and focuses on near-term weakness, I think the downside risk is about 8% to 12%.

While this suggests the upside potential is greater than the downside risk, given the current market conditions and my belief we’re due for a dip, if I were accumulating shares of HITT, I would look for opportunities to do so on weakness. For HITT, this means dips to the very low $50s to high $40s.

As the story goes, it was a shoeshine boy who kept J. P. Morgan from losing it all in the crash of 1929.

According to folklore, one day while shining Morgan’s shoes, the boy offered the Wall Street titan a stock tip. Morgan wasn’t offended, but realized then if the shoeshine boy was in the market, everyone else must be too.

If that was in fact the case, there was no fresh money to send prices higher…and plenty of risk that only modest selling pressure could cascade to a crash. As we know now, the stock market crashed in the fall of 1929.

[Sticklers to history would no doubt point out that J.P. Morgan died in 1913, but similar stories are told about him during the all-but-forgotten crashes of 1893 and 1907, in which he was involved heavilyâ€"Editor.]

So, you might ask, how does this apply to STEC?

In September 2008, when STEC was trading for about $8, I wrote that it warrants consideration as a speculative investment. My overarching thesis back then was that the sharp declines in the price of NAND Flash would lead to an accelerated ramp in the demand for NAND Flash-based Solid State Drives (SSD), and in the enterprise sector STEC was the best positioned company.

Back then, very few people had ever heard of SSDs, let alone STEC, which in fact was named Simple Technology when I first became acquainted with it a decade and a half earlier.

I reiterated my positive opinion on STEC in June 2009, when the stock was trading in the $20s. Obviously, given its sharp upward move, people were beginning to catch on to the STEC story.

However, less than two months later I warned that, between the still rapidly increasing price for STEC and changes in both the supply channel and competitive environment, the party was rapidly coming to a close. Those left would be stuck with the clean up. STEC was trading solidly in the mid-$30s then.

While STEC ended up poking its head slightly above $40 before the party ended, it crashed following that, and didn’t stop until bottoming in the low double-digits ($11 and change) by early December 2009.

Over the next 18 or so months, the natural volatility of STEC made it pretty easy to call five or so successful swing trades from levels where the downside risk was minimal, and profits ranged from 40% to 60%.

However, now that there are maybe a half a dozen competitors in the enterprise-class SSD market, the upside sell targets I would project would most likely be only 20% or so. And, as I see it, the downside risk is similar.

The bottom line: When no one knew what a SSD was, it was easy to make some money in the market. As Dow Theory would explain it, informed buyers were accumulating shares in late 2008 and early 2009, and once the first wave of general awareness hit the stock during the second half of 2009, the informed investors sold their positions.

Following this, STEC turned into a traders’ stock, but with dwindling volatility and rapidly emerging competition, it has now run its course there, too.

While cycle trading was yielding returns in the 40% to 60% range in 2010, the range dropped in 2011, and today we would be lucky to nail one for 20%. Given that is roughly equal with what I see as downside risk, I think it’s now best just to move on and find something new that the "shoeshine boy" hasn’t heard of yet.

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