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Hot Stock Hallmarks of Success for Hardware Companies
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Here's what to look for when you're analyzing hardware companies.

Durable Market Share and Consistent Profitability

Strong profitability and a stable market share are evidence that a wide eco­nomic moat is allowing the firm to fend off competition. Linear and Maxim, two of the chip companies discussed earlier in this chapter, are great examples of this. Although neither one dominates the high-performance analog chip market, they've both maintained steady shares of this fast-growing market, and they've both generated solid returns on capital during even the worst chip industry downturns.

Keen Operational and Marketing Focus

These companies don't spend much time in businesses where they don't have a particular advantage or those that don't fit their strategic focus. Cisco is a classic example on the operations end. Cisco has made the strategic decision not to manufacture things itself; instead, it permits contract manufacturers to make its routers. This focus helps guide decisions about what new kinds of products it wants to make, how it wants to budget its money, or whether it wants to buy a business. Likewise, Dell benefits from this discipline in terms of marketing. It knows that its business is built on directly marketed, built-to-order hardware with an upfront payment model. Ideas or projects that deviate from this model simply don't get funded. Watch out when you see hardware companies dabbling in areas that seem to be outside their strengths.

Flexible Economics

The best hardware businesses have revenues and costs with well-matched timing and levels that can be changed fairly easily. Because demand is so unpre­dictable and volatile in the hardware industry, the more flexibility companies have over costs and capacity, the less risk they face. Good signs of flexible economics include outsourced manufacturing, low capital expenditure requirements, and workforces that are on variable schedules or in low-cost markets.

But even in situations where the company does its own manufacturing, you can look for signs of flexibility or less risk. One of the reasons we think Jabil Circuit is the best contract manufacturing company is that it's the most disciplined in specifying that customers commit to a certain level of volume. Locking in volumes means that Jabil can make more informed decisions about "what costs it takes on. Other contract manufacturers are more likely to accept any deal that comes their way, even though it makes revenues more unpredictable and creates the risk of building expensive capacity and overhead that revenues won't be able to cover.

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