Big Values to be Found in Big Tech

By Brian Shaw - February 23, 2013 | Tickers: AAPL, CSCO, INTC, MSFT, ORCL | 0 Comments

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When Apple (NASDAQ: AAPL) first released the iPad in 2010, it was met with quite a bit of skepticism, with thousands of blogs making statements like "The iPad you buy today will be e-waste in a year or two (less, if you decide not to pay to have the battery changed for you)." Not even three years later, the world has already declared "The Death of the PC" at the hands of tablets and smartphones. In reality, neither of these bipolar views are accurate. However, the market has taken the mobile computing revolution as an opportunity to pick apart the results of big technology companies, and this has created compelling investment opportunities.

These companies are not going away

Big tech companies like Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC) have been trading near 52-week lows as the rest of the market has been approaching five-year highs, as noted by the chart below:

This decline is the direct result of concerns in the market that growth is slowing and that the companies aren't doing enough to capitalize on the shift toward mobile computing. For Microsoft, it is the perceived failure of its Surface tablet to break into an iOS and Android dominated mobile computing market. But there is much more to Microsoft, including the critically important release of Windows 8, the upcoming release of the next-generation XBox, and even the resurgence of Bing. 

Intel is facing similar pressure. While it is true that PC sales are believed to have declined in 2012 for the first time in over a decade, the decline is anticipated to be less than 2%; approximately 350 million computers were still sold worldwide. Is this the beginning of the end for the PC? Not so fast! 2012 was a very tough year economically around the globe, and it is also the year prior to a refresh cycle driven by Windows 8. So, the combination of macro pressures and the emergence of tablets led to a 2% decline in sales; this is not exactly "the death of the PC" quite yet. Plus, Intel has made a push into mobile with its Atom processor, which is already inside Microsoft Surface and Motorola Razr mobile devices (among others).

The entire industry has seen valuation multiples fall

The struggles of Microsoft and Intel recently are not isolated. For example, Cisco (NASDAQ: CSCO) has continued to see its stock trade at cheaper and cheaper multiples. While growth has slowed to less than 10% per year over the past five years, Cisco remains a dominant player in the infrastructure that powers our continuously more-connected lifestyles. In addition to the routers and switches that send data around the world and consumer devices such as wireless routers and cable boxes, Cisco is also heavily invested in providing the hardware to support the growing trends of cloud computing and smart grid investment. With a strong competitive position in each of its product lines, Cisco is poised to benefit as internet traffic increases, the use of data is leveraged for greater efficiency, and computing moves to the cloud.

Valuation multiples have even contracted for enterprise-focused businesses like Oracle (NASDAQ: ORCL). The company remains a strong player in the enterprise application and database market, and has made some smart moves to focus more on higher-margin services and subscription-based recurring revenue streams. However, like the companies noted above, Oracle isn't valued like a company that is operating well and still has meaningful opportunity to grow. 

To illustrate the compression of valuation multiples for these companies, here is a visual of the trending of each company's free cash flow yield over the past 10 years:

The free cash flow yield for this group has risen from 0%-6% a decade ago to 7%-12% today. After digging into some additional metrics, these healthy free cash flow yields will begin to support the thesis that these companies are undervalued.

By the numbers

Here is a look at a few valuation metrics for each of the five companies discussed above:

Each company has a strong balance sheet and solid cash flow generation. What is particularly interesting is just how cheap the shares of each company are from a free cash flow and earnings perspective. Only Oracle has a forward P/E about 10, and with a PEG of just 1.08 even that seems to be a solid candidate for investment. Plus, each company has (or has the potential) to return significant cash to shareholders in terms of dividends; each of the companies noted above has a payout ratio below 50%, meaning that there's plenty of room for dividend growth as well.

So, while the days of explosive growth may be over, there are still plenty of reasons to consider each of these companies going forward.

Which companies are best buys today?

Of the five companies discussed above, three stand out as potential investments. First, Microsoft is generating a free cash flow yield of almost 12%. In addition to returning money to shareholders with a healthy dividend, the company has a tremendous moat with its Windows operating system and Microsoft Office applications. This is a fantastic choice for income investors who are willing to sacrifice growth potential for stability.

In addition to this stable base of entrenched applications, there are growth opportunities in terms of mobile and home entertainment; the XBox as a media center device is an often overlooked market opportunity. Details of the upcoming XBox 720 and how it can serve as a DVR, run apps similar to Apple TV, and other functionality beyond its gaming origins will be important to research. Meanwhile, Bing has claimed 16% of the search market share and is the second most popular search engine behind only Google.

Cisco stands to benefit from the explosion in data traffic caused by the mobile computing revolution. From the hardware that operates data centers to the the trafficking and delivery systems required to get data from the cloud to the user, Cisco has a major role in the growing global network and enterprise IT that is not going away. While growth may only be in the 10% range going forward, a 10% free cash flow yield and payout ratio of just 25% mean that Cisco's already healthy dividend yield will be able to comfortably grow into the future. Like Microsoft, this should be a contender for investors looking for stability and income.

Finally, there is Apple. Apple's valuation and fall from its 52-week high over $700 have been discussed at length, but it warrants repeating. Even if analysts are right and Apple's growth slows to "just" 19% per year over the next five years, the current valuation simply doesn't make sense given the company's industry-leading position, track record of innovation, and enormous cash stockpile equivalent to almost a third of its total market capitalization. Quite simply, Apple's cash flow generation and dividend should appeal to income-minded investors, its growth prospects should still appeal to growth investors, and its current valuation should appeal to value investors. There's really a compelling case to be made for an investment in Apple today for practically anyone!

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