Three Cheap and Profitable Tech Companies
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Selecting good stocks for the long term doesn't need to be very hard -- valuation and profitability are two excellent measures to consider before making a decision. Once the numbers are telling an interesting story, the investor needs to analyze qualitative aspects like a solid management team and durable competitive advantages for the business.
It may sound too simple, but there is a lot of power in simplicity: looking for companies with high profitability and low valuations can be a very smart way to turn you attention into the objective numbers and avoid getting lost in all the subjective comments and opinions about certain stocks.
Quantitative tools can be very effective at screening for companies with strong fundamentals; the investor can then analyze them based on subjective and qualitative aspects of the company like competitive position, management and business opportunities. If the numbers are strong and the business looks good, maybe you've found a long term winner.
The ROE (Return on Equity) ratio is an interesting measure of profitability and it's calculated like this:
ROE = Net Income / Shareholder Equity
It measures how efficient the firm is at generating earnings with shareholders' equity. If a company has a high ROE it can reinvest earnings at a high return, and that means that investors can achieve a nice compounded growth rate in the value of their equity holdings for the long term.
Choosing companies with high and sustainable ROE rates sounds like a reasonable strategy, but investors need to consider valuation ratios too. Even if a company has extraordinary returns, if the price paid is too high, investors can end up achieving lousy returns. For this reason, choosing high ROE stocks with low valuation ratios makes a simple but interesting combination; you are looking for companies with above average profitability and cheap stock prices.
In the following table I have compiled ROE and Forward P/E ratios for three big and successful tech companies -- Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG) and IBM (NYSE: IBM), and these names look good from both a quantitative and qualitative point of view.
Apple has been reporting extraordinary numbers lately, and it looks like nothing can stop the Cupertino giant from growing at fabulous rates in spite of being the biggest company in the world. Of course Apple will face many important challenges in the future, but such an outstanding company trading at a forward P/E below 12 and with a ROE ratio above 45% looks like it still has plenty of upside potential.
IBM can be considered one of the safest companies in the technology sector due to its size and financial stability, the company has a solid dividend growth policy and share buyback plan. Emerging markets, cloud computing and consulting services are some important drivers for future growth at IBM, which has a ROE of 74% and a forward P/E ratio of 12.3.
Google is much rougher than IBM as an investment; the company is embarking in new ventures like the acquisition of Motorola Mobility and launching its own hardware products, which will probably have a material negative impact on profit margins. Earnings at Google are usually hard to predict, and the next quarters could be particularly complicated in that sense.
But the online search leader has a very strong position in its main business: most industry analysts calculate a market share above 70% for Google in desktop search and a dominant 90% of share in mobile. There will be some volatility for Google shareholders in the middle term, but with a ROE barely below 20% and a forward P/E of 12.03 the company has attractive numbers to back its growth story.
Things don't need to be too complicated when buying stocks. Companies with high profitability and cheap valuations are a nice starting point when looking for solid investment alternatives. These three tech leaders have the numbers, and the quality, to outperform the markets in the long term.
acardenal owns shares of Apple, Google and IBM. The Motley Fool owns shares of Apple, Google, and International Business Machines. Motley Fool newsletter services recommend Apple, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.