Is Oracle a Good Stock to Buy?

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Oracle (NYSE: ORCL) recently reported results from its most recent fiscal quarter, which ended in February and is the third quarter of the company’s fiscal year. Business was about flat compared to the same period in the previous fiscal year, with little change in either revenue or earnings. This was due to growth in software being offset by a double-digit percentage decline in hardware (which is a significantly smaller portion of Oracle’s business).

Many technology companies have seen a similar pattern in hardware vs. software in recent quarters, so it is positive to see Oracle handling the transition. In the first half of its fiscal year Oracle was able to increase its net income, but total revenue figures were unchanged and with this quarter’s results in we don’t think we would want to assume much earnings growth in the near future.

As a result, growth in EPS seems to be driven by share repurchases. Earnings per share grew modestly last quarter form a year earlier, despite no change in the bottom line, as share count decreased 5%. With the stock trading at 15 times trailing earnings, however, we would still prefer to see net income improving rather than EPS growing solely through buybacks. In the most recent quarter, essentially all of cash flow from operations was consumed by share repurchases and paying Oracle’s small dividend.

Part of our work at Insider Monkey involves tracking 13F filings from hedge funds and other notable investors. We use our database of filings to develop investment strategies, but can also use it to see which top managers like Oracle. At the end of December, billionaire Ken Fisher's Fisher Asset Management reported a position of almost 20 million shares, making the stock one of its five largest single-stock holdings by market value. The Baupost Group, a hedge fund managed by value investor billionaire Seth Klarman, cut its stake by 23% during the fourth quarter but still owned over 10 million shares.

Other companies providing enterprise software and services include IBM (NYSE: IBM) and SAP AG (NYSE: SAP). IBM’s business is in a similar financial position to Oracle’s: the trailing P/E is 15 and in the fourth quarter of 2012 the company turned in a 6% increase in earnings versus a year earlier based entirely on improved margins.

As with Oracle, we think the stock may be a bit too expensive as of now given current growth rates. SAP is priced more for growth with both trailing and forward P/Es of 20 or higher, and to that company’s credit its sales have been up nicely. However, in its most recent quarter earnings actually slipped a bit compared to the same period in the previous year. It’s possible that the setback is temporary, but we still think we would avoid it at this time.

We can also compare Oracle to Microsoft (NASDAQ: MSFT) and to Workday (NYSE: WDAY), which is a $10 billion market cap cloud computing application software company. Microsoft trades at 9 times consensus earnings for the fiscal year ending in June 2014, but while that does represent value levels we would be concerned that there would be a temporary bump in earnings that year due to sales of new versions of Windows and Office.

A potential value thesis would have to try to normalize the company’s earnings over a longer time frame, though income investors might like Microsoft’s dividend yield of over 3%. Workday IPO’d in October and is up 26% from its levels shortly after that time; the sell-side does not expect it to be profitable either this year or next year, and while it has beaten expectations in the two quarters it has been public we would worry that the “cloud computing” factor may have generated too much excitement about the company.

Oracle and IBM’s valuations are low enough to get our attention, but at least at this point neither company is growing its earnings enough that we would consider it a true value stock. They might be better placed on a watch list to see how business develops in the next quarter or two -- particularly Oracle, which could supplement bottom-line improvements with share buybacks.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in MSFT. The Motley Fool owns shares of International Business Machines., Microsoft, and Oracle.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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