Electronics Stocks How To Pick Them

Since there never has been the slightest doubt about electronics being the biggest growth area of our day, the question is obviously one of choosing the right stocks at their right prices. In order to do the right picking, you would do well to know precisely its areas of coverage, its current stage of development and its probable frontiers of tomorrow based on its already discernible trends.

The word "electronics" scarcely covers its widening areas of operation. Its application has invaded such a broad spectrum of modern science and technology, that every branch of applied science is, in a sense, electronic. Chemistry, physics, biology, these are only a few of the fields electronics has entered.

In turn, such new sciences as solid-state physics have led to the great expansion of the electronics industry by creating a whole new family of electronic devices.

According to Robert Galvin, president of Motorola, his company's scientists have told him: "Progress so far in solid-state science indicates we still have only conceived of about 10 per cent of the useful applications of electronics." Let's renew a few of these applications now.

Solid-State Physics

Integrated solid-state circuitry is the latest development in the industry's ever-accelerating trend toward miniaturization. In essence, an integrated solid-state circuit is a solid-state device in the form of a tiny piece of semiconductor material or a thin film which functions as a circuit in place of many electronic components. It will amplify or control electronic current just as ordinary electronic circuitry would but without the latter's interconnecting components and other complexities. The other purpose is to upgrade the basic unit in a system from a component to a function, i.e., amplifying, switching.

Just think of a single piece of crystal or a thin film doing the job of hundreds of components, and you have some idea about the vast implications of integrated solid-state circuitry. Commercially, for example, it may mean wrist television for ladies. Perhaps employers will soon have trouble in keeping up the efficiency of employees, each with a wrist television alongside the typewriter or comptometer, especially when global color television, relayed by orbiting satellites, becomes reality.

I cannot recall any other single development, even in revolution-prone electronics that can compare in potential implications with the Westinghouse announcement in December 1959 of its ability to grow a whole circuit in a tiny block of semiconductor material. It needs no electronics specialist to visualize what this means. For instance, right now, large computers are composed of hundreds of circuit boards, each with a whole assembly of capacitors, resistors, etc. Each circuit board performs a single electronic function such as amplifying or switching. Now, each of these circuit boards will be replaced by a single piece of crystal or thin film.

A Big New World of Tiny Wonders

Integrated solid-state circuitry seems to have already outdistanced another tiny wonder, the tunnel diode, which itself was unknown in this country less than three years ago. Until then the transistor was king of electronic miniaturization. It was a Japanese physicist named Leo Esaki (a consultant with IBM) who first discussed the tunnel diode in January 1958 in a technical journal, Physical Review. The tunnel diode does most of what the transistor does, only better, faster and cheaper.

At first, Dr. Esaki's article barely caused a stir in this country; then a few electronics firms began to grasp the tremendous potential. Only about the size of a pinhead, the tunnel diode is now rated by General Electric to be up to 100 times faster than the transistor in some applications. As small as a hundredth the size of a transistor, a tunnel diode needs as little as 1 per cent of the power to perform the same functions. It is simpler in structure and operates efficiently at extreme temperatures as well as high frequencies.

The two tiny wonders, however, have much in common. Both amplify and/or control electrical impulses. Both consist of the semiconductors, silicon or germanium. Their difference is rather in the amount and nature of foreign matter mixed into the semiconductor material. This foreign substance is substantially higher in tunnel diodes and forms a sort of thin barrier through which the current tunnels at the speed of light.

Why the Trend Toward Miniaturization?

The electronics industry has always tried to reduce the size, weight and cost of its equipment, though the need for small, lightweight devices took priority over cost-cutting, particularly with the military. Military electronics have led the way toward miniaturization and "ruggedization." This is especially true in space and missile programs where the size of equipment and power supply are critical. In most cases, miniaturization means not only higher reliability but also longer life, since the tiny components generally have fewer parts and generate less heat.

As a rule, miniaturized components are more expensive than their larger counterparts. For instance, a standard-size potentiometer may cost as little as 59¢ whereas a miniature may come to $6.50 because of special tooling and testing.

In this ever-accelerating miniaturization drive, electron tubes have shrunk from the diameter of a thumb to that of a lead pencil. Resistors, capacitors and other components have become much smaller, too. For instance, research-minded Aerovox Corporation has come up with its Cerafil ceramic capacitor, one of the smallest capacitors ever designed. A new company, Vitramon, produces a solid-state porcelain capacitor which is the only capacitor of truly monolithic structure available commercially.

Component vs. Functional Miniaturization

The end of the miniaturization drive is still far from view. The latest emphasis appears to be shifting from component miniaturization to functional miniaturization; that is, from mere miniaturization of components to complete elimination of components by use of integrated circuit functions.

Among the leaders in the miniaturization drive are Westing-house Electric, Texas Instrument: and Motorola. A small company called Varo Manufacturing also has a sizeable stake in the integrated solid-state circuitry. Varo's method of making integrated circuits through an evaporative deposit of a thin film of one material on the substrate of another is considered less "progressive" than Westinghouse's growth of entire pea-size circuits in one piece. However, the former appears to have the advantage of production economy.

In order to explain the meaning and vast implications of the integrated solid-state circuitry, Robert Galvin, Motorola president, showed the New York Society of Security Analysts, in August 1960, tubes made during; World War II, compact for their day. Then he showed the same circuit in printed wiring and transistors as it would be done today—about one two-hundredth the size of the tube circuit.

Next, he showed the same circuit, made in integrated solid-state thin film in Motorola laboratories. It looked like a printed black dot on a sheet of paper. Yet in this dot, Galvin said, were the equivalent of two transistors, four capacitors and six resistors.

New Electronics Horizons

New advances in physics have raised the possibility of other electronics applications. According to Dr. Guy Suits, vice president of General Electric, his company's research has linked two rather exotic fields of physics research—one concerned with superconductivity and the other with the electronic process called tunneling.

Superconductivity is the phenomenon that manifests itself in some materials at extremely low temperatures where some metals become perfect conductors of electricity. Tunneling, as you have seen, is a phenomenon in which some significant portion of an electric current penetrates a nonconducting material if the material employed is thin enough.

Research by Ivar Glaever, physicist at General Electric Research Laboratory, has put these two fields together with important results. Though a superconductor is a perfect conductor of electrons there is a group of specific electron energies "forbidden" to any given superconductor. To electrons in this range, called the "energy gap," the superconductor acts as a reflector or insulator. The energy gap is revealed when electrons are allowed to tunnel through a thin insulating layer into a superconductor.

A further development that makes the research especially promising for future practical applications was reported independently in the Physical Review Letters by Mr. Glaever and three scientists of Arthur D. Little, Inc., of Cambridge, Mass. The scientists were Dr. James Nicol, Dr. Sidney Shapiro and Dr. Paul H. Smith. This was the discovery of what is called a negative resistance region appearing when currents were tunneled at certain voltages between two superconducting metals. These advances constitute an important scientific discovery that had "raised the clear possibility of a whole new family of electronic devices."

Two Ways of Buying Electronics Stocks

While the promise of reward in investing in the right electronics stocks is big in view of its clearly defined growth pattern, picking the right ones is a tricky business. For one thing, most well-known electronics stocks sell at a premium, even in a troublesome market. For another, to buy stocks at 20, 30 or even higher times earnings demands that their earnings go on rising sharply—which is a daring supposition at best.

Stocks which are likely to continue commanding high earnings multiples are those which can outperform the industry in rapid growth and high profitability. For the average investor, preference should be given the strong companies with entrenched positions and with a broad product mixture such as Litton Industries, and Thompson Ramo Wooldridge in military electronics; General Electric, Motorola and Zenith Radio in consumer electronics; American Telephone & Telegraph in communication electronics.

Litton has shown its outstanding capability in choosing acquisitions and then improving their operations. Thompson Ramo Wooldridge has become a major factor in space electronics through its Space Technology Laboratories, Inc., subsidiary with its new area of growth now overshadowing its automotive and aircraft component business.

General Electric is expected to show substantial improvement as a result of many of its major research programs covering a host of new growth areas. Motorola is important in consumer and industrial electronics. Zenith has achieved an enviable record of growth and profitability in the highly competitive consumer electronics field and is expected by William Lowitz of E. Lowitz Sc Co. to reach a new earnings plateau through, among other things, strengthening its leadership in television by entry into the color TV field.

Though basically a telephone utility, American Telephone & Telegraph is a major participator in electronics through its Bell Laboratories and Western Electric subsidiary, which are the nation's strongest electronics research and largest electronics producing outfit respectively.

Venturesome investors probably should concentrate on smaller companies with big brains. They are preferred to larger companies because the latter's inevitable interests in many cyclical, slow-growth and nongrowth areas are likely to offset the importance of anything spectacular they may do in electronics.

A Pattern Analysis for Testing Electronics Bargains

An obvious alternative to buying prominent electronics leaders is to buy stocks which are underpriced in relation either to their inherent values or to the industry average.

For example, in its December 6, 1960, survey, Shields & Co. found the unheralded virtues of General Precision Equipment to be far underpraised by the market.

Selling at about 16 times earnings, this or any stock would be considered underpriced because of its following virtues: (1) The company possessed one of the most imposing collections of scientific skills in U.S. industry. (2) It produced a sweeping array of products in a great number of growth areas including Doppler navigation, inertial guidance, computers, infrared and optics, servomechanisms, microwave technology and semiconductors. (3) Though heavily dependent upon government contracts, the company's "scope of contracted brain work is such that shifts and cancellations seldom do much damage to over-all volume."

The "unheralded virtues" of General Precision are enumerated here in order that readers may apply them in search of other underappraised electronics stocks.

Melpar, Inc., a division of Westinghouse Air Brake, for instance, appears to meet the first requirement in that it possesses one of the greatest assemblies of scientific and technical skills ever gathered under one corporate roof. Melpar has 1,500 engineers, physicists, mathematicians, chemists, etc.—1,000 with scientific degrees—plus 1,000 technicians. Raytheon seems to meet the second requirement in that it operates in such a number of glamorous areas for a company whose stock is still available at a moderate earnings multiple. The Martin Company appears to meet the third requirement in that it is involved in a greater number of missile programs than any other government contractor and, therefore, should be less vulnerable to defense shifts and cancellations.

So, you see, a good analysis of an "underpriced" situation like Shield's on General Precision provides a good pattern for analyzing and spotting others.

Opening Back Door to Electronics

"Many companies in recent years have established important electronics divisions," said Financial World, "yet remain classified as auto-parts, rail-equipment or printing-equipment makers, and are still evaluated on the relatively moderate earnings multiples commanded by these groups." Among others, Financial World listed Harris-Intertype, Bendix, and Globe-Union, as "back doors" to electronics.

Harris-Intertype has branched out from its primary field of activity—printing equipment—into electronics through the acquisition of Gates Radio Company in 1957 and Polytechnic Research & Development in late 1959. While electronics now accounts for about a fourth of its business, its stock is still selling at a comparatively low earnings multiple in line with its classification as a printing equipment firm.

Bendix is fast increasing its stake in electronics; 40 per cent of its products are electronic in nature. However, in the mind of many investors, Bendix is still an auto-parts firm and, as such, is accorded a considerably lower earnings multiple than its fast-growing electronics division seems to deserve.

Globe-Union has a growing stake in electronics through its Centralab division, which is an important maker of packaged circuits for both defense and industrial electronics. However, the stock is given only a conservative market evaluation because of its classification as a battery company.

Other Off-beat Electronics Issues

Other unusual electronics issues listed by Financial World were: Stewart-Warner, an auto-parts firm with the growing importance of its electronics division still to be fully recognized; P. R. Mallory, a battery company with a newly established electronics division which underscores its growing position in such products as contacts, capacitors, resistors, rectifiers and switches; Westinghouse Air Brake, a rail equipment firm, with an electronics subsidiary called Melpar, Inc., now accounting for about 30 per cent of its sales; ACF Industries, a rail-car maker, with growing electronics and nuclear activities; General Precision Equipment, which though active in many areas is deriving nearly three fourths of its volume from defense electronics.

There are, of course, many other companies which, though classified otherwise, have either just diversified into electronics or already become a sizeable factor therein. Wurlitzer and Bulova Watch, for example.

Widely known for its musical instruments, Wurlitzer has a little known but fast-growing electronics and defense-products division operating in the glamorous field of underwater detection systems. Bulova is, of course, a watch maker, but it has a rapidly growing division in defense electronics.

Other examples are Clevite Corporation and Burndy Corporation. An auto-parts firm, Clevite has become an important factor in solid-state electronics, especially since its purchase in April 1960 of Shockley Transistor Corporation from Beckman Instruments which can materially increase Clevite's semiconductor research and development capability and add new products.

As for Burndy, it has undergone a dramatic change from an old-line electrical equipment producer to a fast-growing supplier of vital components for the rapidly increasing electronics market.

This dramatic shift was provided by Burndy's Omaton Division, where new product development has placed Burndy squarely in the space-age category. Output is accelerating rapidly in this division. Omaton's volume has expanded from 37 per cent of Burndy's total in 1957 to 50 per cent in 1959. Next year it is expected to comprise 75 per cent of the total. The rapid shift into electronics should provide substantial improvement in sales and earnings.

Should You Buy Merger Situations?

In these days, investors are in the habit of paying a high premium for companies involved in a merger, in the belief that a merger would strengthen the competitive position of the companies. Actually whether or not a merger will work out depends on a lot of things. To say that every combination of companies will be a good thing is tantamount to saying that every marriage will have a happy end.

A "combination" is likely to succeed in cases of carefully planned mergers of firms with compatible or complementary product lines; otherwise, more often than not, mergers result in such things as poor digestion and incompatibility.

Throwing businesses together merely for the sake of aggrandizing corporate structure only swells volume with a shrinking profit margin—the worst thing that can happen to a business.

The acquisition of Continental Electronics Manufacturing by Ling-Altec Electronics provides us with an excellent pattern for analyzing other mergers and acquisitions. According to Ling's President, James J. Ling, this acquisition will increase Ling's backlog by a staggering 425 per cent and sales by 85 per cent. And that's not all. The real beauty of the situation, say the experts, lies in the price Ling-Altec paid for the massive backlog, sales and earning power of Continental: $3.5 million cash, a $125,000 straight note and a token 10,000 shares of common stock. Each share of Ling-Altec common before the combination was expected to generate about $26 in sales for 1960. On the other hand, each of the 10,000 shares relinquished to Continental will return nearly 3,000 sales dollars to Ling-Altec; a genuinely dilution-free acquisition.

The Pitfalls of Merger Situations

In their eagerness to diversify into electronics, some aircraft companies have paid as much as three sales dollars of their own business for every one of the concern to be acquired, or traded per-share earnings of $1.50 for per-share earnings of 5O¢. The result is, of course, common-share earnings dilution, the very opposite of what a merger is supposed to accomplish, since earnings is the most important single reason for anybody to enter into any business.

It may be justified to pay a high premium for an electronics concern which eventually would increase per-share earning power. That, however, does not change the fact that the merger is hampered by a high initial cost. It would be a lot better if no initial premium were paid. It would be better still if below-the-average cost should be paid for a concern which has not just a touch of electronics, but operates, as Continental Electronics, in one of the most exciting electronics areas today—high-power transmission equipment. The subsequent dramatic price appreciation of the Ling common over-the-counter should come as no surprise, especially to those who knew how the earnings potential of this Ling-Altec-Continental combination had been sharply elevated.

These are the things to look for in a merger situation. Before jumping into one, you should ask at least one question. How will the merger affect per-share earnings? This is, of course, not all that you should know; however, it will save you a lot of trouble if you get the answer before getting into any merging stocks.

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