Why Digital Has Lost Half Its Value

Investing

By Lawrence J. Demaria
The New York Times

August 28, 1988

MANY stocks have come down to earth since the market peaked on Aug. 25 of last year, but few have made a thud as loud as the Digital Equipment Corporation.

Digital's stock has fallen all the way back to 1986. Recently, Digital common traded at $92 a share on the New York Stock Exchange, or $107.50 a share lower than its 1987 high. And although the stock recouped slightly last week, some analysts believe the worst is not over for Digital.

''The wonder is all of these people who have held it all the way down,'' said Justin Mamis, chief technical analyst for Cowen & Company.

Not many people are blaming Digital, a premier growth company many analysts still recommend. Some analysts have trimmed their 1989 earnings estimates. But why has an average 10 percent trim in projections led to a 50 percent plunge in the stock's price?

''That's a million-dollar question,'' said Carol E. Muratore, who follows Digital for Morgan Stanley & Company and has recommended the stock all year. Actually, it's a multibillion-dollar question. Since their peak 1987 price of $199.50, Digital's 127.8 million common shares have lost almost $14 billion in market value.

The answer is that Digital has experienced the downside of being a big institutional favorite. It has been regarded as a proxy for the market and the economy at a time when institutional investors have strong doubts about both.

A comparison with Digital's main rival, International Business Machines, shows that I.B.M. is five times larger than Digital in annual revenues (more than $54 billion for I.B.M. compared with more than $9 billion for Digital) and in profits (more than $5 billion for I.B.M. against more than $1 billion for Digital). But because Digital's main customers are Fortune 500 companies, many experts consider it a better stock market and economic barometer than I.B.M. In good times, institutions own about half of I.B.M.'s 591.6 million common shares outstanding, but about 75 percent of Digital's shares.

When the stock market is surging, both stocks typically run way ahead of the pack. But when the market turns bad, and both stocks are dumped, Digital falls more sharply. I.B.M.'s stock is off about 40 percent from its peak last year and would presumably be down even more if hundreds of thousands of smaller owners were not loyally hanging on. They at least have I.B.M.'s $4.40-a-share payout to comfort them; Digital pays no dividend.

''We're talking about a stock that did not rally well after the crash,'' Mr. Mamis said. ''It's the only major name that's below its crash lows. That is what happens when you have an over-owned stock. It's an institutional darling that has gone sour, with a vengeance.''

As a technical analyst, Mr. Mamis is more concerned about Digital's stock action than such fundamental gauges of performance as sales, profits and cash flow. But he argued that with the fundamental analysts scaling back their optimism about Digital, there was even less reason to own the stock. He does not believe that now is the time to start accumulating it. ''I've got a target of $80 to $85,'' Mr. Mamis said.

Miss Muratore of Morgan Stanley said the company was a good buy now, even though ''Digital is something of a lightning rod for concerns about the stock market, for concerns about the economy.'' She estimates Digital will earn $11 a share in fiscal 1989, which ends next June. In the fiscal year just ended, Digital earned $9.90, which means that the stock is selling at less than 10 times its earnings for its latest 12 months. While few analysts expect the stock to sell again at the price-earnings ratio of 23 it hit at one point last year, a more normal multiple of, say, 13, would put the stock at around $140, if Miss Muratore's earnings forecast proved correct.

Miss Muratore said Digital's strength was in selling computer networks to increasingly decentralized American corporations. ''I.B.M.'s approach has been centralized computer systems,'' she said, while Digital, through its vaunted VAX computers and its software, helps companies connect all sorts of personal computers for many applications.

WHILE I.B.M. is the mainframe king, Digital's networks permit corporations to use even their I.B.M. computers better, Miss Muratore said. ''Digital has moved out of the minicomputer ghetto,'' she added. ''Digital's networks basically make PC's more useful.'' Just last Tuesday, Digital announced a new hardware-and-software line that allows VAX's to connect and share files with I.B.M. machines.

Miss Muratore is not concerned by inroads made by the Japanese. She said that, while Japan had a large economy and strong computer companies as well as technology, the American market, where Digital was solidly entrenched, was so huge that even the Japanese would have a hard time ever dominating it.

But while Digital may prosper, its shareholders may not. In a bear market like the one Wall Street is experiencing now, stocks like Digital will probably lag. And many analysts and investors fear what will happen to technology stocks in a recession. Digital, with its clientele of large corporations, could be particularly vulnerable.

The dangers in owning Digital are easy to see. As recently as March, many analysts were praising the stock. A Dillon, Read analyst said, ''We still think Digital is a high-quality growth company and we recommend the stock.'' A Salomon Brothers analyst said: ''We now believe that the time has arrived to be an aggressive buyer.'' And a First Boston analyst called Digital ''a buy right now.'' At the time, Digital was selling at $120.50 a share.