Why it Pays to Look Beyond the Story
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The tech sector is full of innovation opportunities and potential for growth. However, choosing an investment without checking the numbers behind each company is not the best way to select long term holdings. The trade-off between growth and valuation needs to be analyzed before committing to a technology stock, even if the qualitative aspects of the business look attractive.
Too many investors jumped behind Facebook (NASDAQ: FB) without doing their research on the company´s attributes as a long term investment. Perhaps for that reason, most of them could be regretting that decision. Facebook is a very innovative company with disruptive potential, but the numbers make it look expensive and its strategy is not yet clear.
Facebook is trying to find a way to adapt to the mobile revolution, and is also innovating with different advertising methods. This is a smart company which provides something valuable to its users, but it is not necessarily a great business at this point. Analysts are expecting almost 36% annual growth in the company´s earnings per share over the next five years. Facebook has the potential to achieve that and more, but it still hasn't shown a credible plan to achieve those results.
At a P/E ratio above 100, Facebook carries a PEG ratio – valuation adjusted by growth expectations – of 2.9, which means the company looks expensive even if it achieves those growth rates. Facebook is expensive under strong growth assumptions, and the company is still experimenting with revenue models. Thus it doesn´t look like a strong buy at current levels.
One company which looks attractive from an analysis of valuation and growth expectations is Apple (NASDAQ: AAPL). The company run by Tim Cook has an expected growth rate of 21.4% annually over the next five years. But Apple is delivering numbers well above that currently, and even if growth slows sensibly in the future, those kinds of figures are not hard to achieve for such a successful company.
If Apple delivers on those numbers, the company will appear cheap from a valuation point of view; it has a forward P/E below 11 and the lowest PEG of the group below 0.7. In the case of Apple, the numbers look good under conservative assumptions, quite the opposite of what Facebook has to offer from a quantitative point of view.
The qualitative aspects still matter in Apple's example, and the company is strong in that respect. It has more than $110 billion in cash and liquid investments in its balance sheet, which provides a lot of flexibility into the future. Few companies in the world have such a valuable brand and differentiated image.
Those who focus on low valuations and conservative positions may want to take a look at Microsoft (NASDAQ: MSFT). Mr Softee is trading at a Forward P/E of less than 10, which is very attractive for a company with such financial strength and big cash flows. Analysts are expecting a 10% annual increase in earnings for the next five years, which doesn´t sound so exciting, but much easier for Microsoft to reach those figures. For a value conscious, low risk alternative in big technology stocks, Microsoft could be a nice candidate.
Those looking for a more innovative bet with higher growth potential and a moderate valuation may want to consider Google (NASDAQ: GOOG). The company is very reasonably priced at a Forward P/E of 11.5 and with growth expectations near 19%. The ride could be volatile in Google, the online search giant is getting into the low margin business of hardware, and the competitive landscape changes by the minute. Google is prone to both positive and negative surprises over the next years, as the company is embarking in many innovative projects.
On the other hand, Google is the undisputed leader in online advertising, and is adapting successfully to the mobile revolution with its popular Android operating system for smartphones. Google also owns many valuable properties, like YouTube, which has the potential to become a big high growth business over the middle term.
The qualitative aspects of an investment in the tech sector are determinant and even irreplaceable. But the numbers can confer a lot of information about expectations and valuations, which are both critical factors when looking for the best long term returns.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Facebook, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, and Microsoft. 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.If you have questions about this post or the Fool’s blog network, click here for information.