Are These Tech Giants Good Buys?

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

Many times in this blog I have stressed that valuation multiples are static. They do not reflect business or corporate trends and if those trends are not stable then multiples can change really fast. A good example of this would be Research In Motion. The company seemed cheap in early 2011, but a few months later, market share trends changed and the stock went from $55 in April to $25 by August. That is the reason why you should understand what is going on in the industry before you invest your savings in any company. Here I will make the case for two corporate titans that, right now, seem cheap relative to its fundamentals: Intel (NASDAQ: INTC) and Microsoft (NASDAQ: MSFT). Are they really cheap or you should avoid them?

MSFT, which is up by 6.6% in 2012, is a cash flow machine. Its main product lines, such as Windows and Office applications, are an industry standard and constitute an actual annuity. The problems are not to be found in the present, but in the future of the company. Given current market prices, most investors believe MSFT will not be the cash machine it is today for much longer: ex cash (MSFT will hold over $73 billion in cash by the end of 2013) the company trades at 2013 6.3x P/E. MSFT is being threatened by the decline of the PC era and the surging demand for products such as tablets and smart phones where MSFT has little presence. Even if the company is still growing (revenues are expected to grow by 22% in 2013 thanks to the recent launch of Windows 8) I would stay on the sidelines. Yes, MSFT is not Google that keeps all its cash in its pockets. MSFT does pay a growing dividend yield (now standing at 3.4%), but the company is not a smart acquisition machine and the future is not being well defined by management. Besides, it’s too big to constitute an M&A target. MSFT will probably remain the cash flow machine it is today ten years from now but, just in case, remain on the sidelines for now.

I remember Intel was the one and only example that professor Greenwald at Columbia University could give of a high technology company that had developed strong competitive advantages. The main argument is based on the fact that INTC is so dominant in the chip industry that it can invest much more money in R&D than its competitors and still be much more profitable than the others. If any small company creates something that INTC might need then Intel just has to go and buy it out. Huge market share, financial strength, and great management are three of the main characteristics defining INTC. Besides, INTC is growing hand in hand with demand for tablets and smart phones. Its 2012/2013 Year over Year (YoY) revenue growth rate is expected to be around 5.6% with expected EBITDA margins of stable at around 48%. This absolute market leader trades at 2013 9.4x P/E and 5x P/OCF. If this was not enough, Intel pays a 4.3% dividend yield. I would just go long.

As any investor knows, it’s very tough to predict a market that is changing fast. That is exactly the case for tech companies. That said, MSFT and INTC are two mature companies that have successfully survived all the changes that took place during the last 20 years in the computing industry. Apparently the market is predicting that this time it might be different since share prices for INTC and MSFT seem low relative to current fundamentals. Even if that could be the case for MSFT, it’s most definitely not the case for INTC. Intel has developed fantastic scale economics and I could bet that the company will continue to thrive decades from now. Meanwhile, you can enjoy a fairly good 4.3% dividend yield. 

martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel and Microsoft. Motley Fool newsletter services recommend 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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