Why Big Profits Are Coming in at These Tech Giants

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

Market sectors go through cycles just like the overall market. Investors who can learn to cast aside popular negative sentiment and buy world class businesses when they are on sale will find themselves compiling safe, steady gains over multi-year periods without the angst and anguish suffered by many people with less carefully selected positions.

It’s Time to Be Greedy in Big Technology

Warren Buffett once said that investors should be fearful when others are greedy and greedy when others are fearful. Based on the current valuations of four enormously successful technology businesses, many investors appear to be fearful; so, now is the time shrewd investors should become greedy. Ten years from now, many who are fearful today will be looking back and wishing they had taken Mr. Buffett’s advice.

Today, many value investors who never previously considered owning technology related businesses due to high valuations are buying them as prices have fallen declined to very attractive levels. Does anyone really believe that technology giants Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL), Cisco Systems (NASDAQ: CSCO) and Intel (NASDAQ: INTC) have suddenly become so poorly run that they deserve valuations equal to only about 50% of the market average based on common valuation metrics? If you don’t then you must believe these businesses are priced based upon irrational fear and present an exceptional opportunity.

With the S&P currently priced at around 18 times 2013 projected earnings and a 15.8 times cash flow, it would seem reasonable to assign a similar valuation to any large, well run business that has moved beyond its fast growth years but remains enormously successful today. Let’s take a quick look at how these four stack up and what we should expect as the market corrects the current error in valuations.

The King of Business Software

Microsoft’s main software products, Windows and Office, dominate the business world. They are also a lot like Rambo and Rocky movies in that you can bet a new version will be out soon and a lot of people will buy it. After all, if you are running a business, you have to have software compatible with that being used by your customers.

Microsoft stock would have to rise 80% to trade at a price to earnings multiple equal to the S&P, 60% to match the market dividend yield of 1.99% and 23.4% to trade at the same price to cash flow multiple. Add the fact that Microsoft has cash, short-term investments and receivables equal to slightly more than 34% of its total market capitalization and this is one enormous value.

The Former King of Cool

Apple has almost certainly lost its status as the only maker of a mobile device that one must hold in one’s hand in order to be cool. Attempting to regain that lofty status will, in all likelihood be as difficult as returning the proverbial genie back in the bottle. Apple might well have victimized itself by introducing new products at such a rapid pace that it failed to deliver the significant improvements required with each new model to justify the substantial expense involved for consumers to upgrade. Apple’s miscalculation and the market’s overreaction to it have created an enormous opportunity for those who fail to be intimidated by the fear that is pervasive in the market today regarding Apple’ stock. Apple may have stumbled a bit but nothing that justifies a 35% drop.

Apple’s share price and would have to nearly double for the price to earnings and price to cash flow multiples to equal that of the S&P 500 average today. With a dividend yield 25% higher than the market, Apple might not be the only maker of “must have” handheld mobile devices any longer, but it is not going away quietly and is grossly undervalued at the current price.

A New Chip Off an Old Block

Like me, there are many people who think of Intel every time they turn on their computer and see the little decal on it that says: “Intel inside”. Intel dominates the market for computer processor chips and stays on the leading edge of the industry with massive capital spending from its enormous cash flow. Even though demand is slowing for desktop and laptop computers, it is still a massive market and will be with us for years to come.

Intel does understand the need to change with trends in the market and is now quite successfully offering its excess manufacturing capacity to fabless chip designers and mobile device makers. The beauty of this strategy is that they are simply selling capacity within buildings and equipment that already exists during times when the equipment is currently not in use. This practice increases return on capital and assets and floods the bottom line with profits since the only requirement is to run the existing equipment more. With a price to cash flow multiple 64% below the market, price to earnings multiple 38% below the market and a business that dominates its industry, Intel is simply a steal at the current price.

The Backbone of the Internet

It is hard to believe that a business commonly referred to as the “backbone of the Internet” could be valued 39% below the market average P/E ratio but that is exactly where Cisco Systems sits today with a forward P/E of 11. Even more shocking is that its price to cash flow multiple would have to rise over 70% to equal that of the index.

Cisco will be heavily involved in building the servers and networks that will be critical to the successful movement to cloud computing and will be indispensable in the coming upgrades required to keep the Internet functioning and viable.

Foolish Actions or Foolish Actions

Fools (big F) will rush in now and buy all four of these technology giants while the prices remain at foolish (little f) levels.

Ken McGaha owns shares of Microsoft, Cisco Systems, and Intel. The Motley Fool recommends Apple, Cisco Systems, and Intel. The Motley Fool owns shares of Apple, Intel, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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