Tech Industry Analysis:

Legendary investor Stan Druckenmiller tells a story of turning in his first report as a young analyst, very proud of his fundamental research, charts and analysis.

“This is useless,” said his boss. “What makes the stock go up and down?”

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2/14 Benton Rules

That simple question made him change his entire approach:

“Thereafter, I focused my analysis on seeking to identify the factors that were strongly correlated to the stock’s price movement as opposed to looking at all the fundamentals.”
3/14 Benton Rules

In that spirit, here are the Rules for Technology Stocks set down by Dan Benton, when he was a top ranked PC analyst at Goldman Sachs (1988 – 1993). Much of it remains valid today.
4/14 Benton Rules

1. Sell technology stocks when estimates are being reduced.

2. Buy technology stocks only for positive earnings surprises.
5/14 Benton Rules

3. Positive earnings surprises occur when revenue and earnings growth are accelerating, when average selling prices are rising, and when gross margin and operating margin are rising.

4. Most technology stocks ideas are product-cycle stories.
6/14 Benton Rules

5. New product cycles often lead to earnings surprises; product cycle transitions usually lead to earnings disappointments.

6. Technology stocks also do well when companies rebound from periods of poor execution.
7/14 Benton Rules

7. Value investors don’t make money in technology. There are few ‘cheap’ technology stocks.

8. Don’t buy on relative P/E, P/B, P/R, particularly when estimates are falling (see Rules 1 and 2).
8/14 Benton Rules

9. Technology stocks performed poorly in the summer.

10. Seasonal slowdowns cause secular concerns.

11. Second-tier companies do poorest in the weakest seasonal periods and provide anecdotal evidence of an industry slowdown.
9/14 Benton Rules

12. Reorganizations without restructuring charges usually lead to earnings disappointments within two quarters.

13. One-quarter problems exist (but only if caused by supply constraints).
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14. Management usually appears weakest at the bottom of a product cycle.

15. Insider selling doesn’t matter; management gets new stock options every year.
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Old World/New World:
16. Traditional mainframe and minicomputer companies are in secular decline.

17. It is increasingly difficult to differentiate companies that sell microprocessor-based computers.
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18. Execution is the most important distinguishing factor in a standards-based world.

19. It is hard to forecast execution.
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20. Don’t forget Rule 1.
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Me: As you can see, some of these rules are dated (“mainframe and minicomputer companies”) but you can always update the phrasing to match new times and new products.

Hope you enjoyed.

You can also use Benton's Rules when reading current analyst reports.

Example: Is Winter really coming? Or did the analyst look at 2nd tier companies (Rule #11) during a seasonally weak (Rule #9) time of year?
Addendum: The Benton Rules work better for Hardware than Software/Web. Keep in mind they were written years before the Dotcom Boom. Great question from @minato71216

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