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Wednesday, April 20, 2005

GOOG, YHOO and EBAY are NOT Tech Companies

One of my pet peeves with the stock market today is uthat people are ignorant when it comes to understanding the companies that they invest in. Take the “Tech” category. This category is used to classify any and all companies that have anything to do with technology – software makers, network equipment, mobile phones, internet advertisers, etc… This ignorance by the larger markets actually creates investable opportunities by the savvy investor. This is because certain companies trade in sympathy with other companies that are the bellweathers of the sector, when in fact they have very little to do with each other.

This earnings season was a prime example. It started off with a few technology companies reporting horrible earnings relative to expectations. IBM came in very low and caused a market-wide decline for a few days. Other software related companies also reported below expectation performance. Interestingly, this decline took down a lot of companies that have absolutely nothing to do with IBM’s business of creating and maintaining software and hardware systems for other businesses.

For instance, why Google, Yahoo and eBay are classified as “Tech” companies is unknown to me. In my world, I use a simple rule to determine whether or not a company should be classified as Tech: Does this company sell to the IT department of other companies? I like to use end-user definitions to segregate my sector categories because it helps to evaluate which companies to invest in. Understanding the end-user/purchaser makes analyzing a company’s products and services much easier. I can look at a networking equipment company and understand whether their router has a big addressable market and whether or not their offering is competitive amongst other offerings.

Using this classification scheme, Google, Yahoo and Ebay have nothing to do with IBM, Compuware or other software companies. More importantly, they shouldn’t trade in sympathy with them.

Think about it, Google and Yahoo!s end-customer is the advertising department of pretty much all businesses on one side and the minds of consumers on another. That market definition is COMPLETELY different than IT department heads and has different dynamics. IBM’s business is dependent on technology buying cycles which have a high beta to business cycles. IBM is the penultimate Tech company.

Google and Yahoo!’s businesses are being driven by a secular change in advertising, namely that some of it is moving online. This trend is not affected by technology buying cycles. Maybe there is a s malleffect based upon how many healthy Tech companies are around and willing to buy advertising on their sites, but that’s it.

The point of this laborious essay on the fine points of sector categorization? It can help the Tech investor make money. When IBM brings the whole “Tech” sector down because of weak IT spending, buy the companies that actually are not “Tech” and are driven by different market dynamics.


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