Business Computing 101: 2 Ways to Play this Sector
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The quarterly results for business computing firms have been weak. Which of these stocks are trading at price multiples that are cheap enough to justify the risk of jumping into an industry with declining sales and earnings?
IT Investment is Down
Intel (NASDAQ: INTC) and IBM (NYSE: IBM) have been on the losing end this week in terms of stock performance. All the same, many blue-chip tech companies, such as Dell (NASDAQ: DELL) and Oracle (NASDAQ: ORCL), suffered the same fate as these two giant chip manufacturers. The third quarter results issued by the two chip giants on Tuesday afternoon were rather disappointing, which led to the two stocks to underperform the Dow Jones Industrial Average.
Needham analyst N. Quinn Bolton wrote, "Weakness in the segment was driven primarily by softening within the overall enterprise IT market as CIOs and CTOs determine where they will allocate resources." In short, Intel's poor performance was due to reduced capital expenditures by chief information officers and chief technology officers in other companies.
IBM's situation was no different, as it was awarded a neutral rating due to the indifferent results that it had posted for the quarter. Although the company has margin leverage to cushion lower sales, in the long run this is not a sustainable strategy. Janney Capital Market analyst Joseph Foresi wrote, "The company has margin leverage to protect earnings, but that runway will become tougher in the face of declining revenues."
Checking for Value
Not all business computing stocks are trading at valuation discounts that reflect a challenging environment. Shares of Oracle are not trading low enough at $31 to compensate investors for its risks. Investors can buy more revenue per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.32, while Oracle has a much higher 3.98 ratio. Oracle shares are trading at a fair 15.09 price-to-earnings ratio, in line with the S&P 500's average.
Next, let's consider "Big Blue." Unfortunately, IBM shares are not trading low enough at $193 to compensate investors for the risks either. The firm's 2.08 price-to-sales ratio is in line with today's prevailing market multiples. IBM shares are trading at a fair 14.06 price-to-earnings ratio, also in line with the S&P 500 average.
IBM is not much of an income investment either. Its 1.76% dividend yield is comparable to the 1.82% 10-year treasury yield. Future dividend payments are likely because the company pays out 0.22 of earnings as dividends, so earnings could drop considerably before dividends must be cut.
Shares of IBM are about as attractive for income investors as shares of Microsoft (NASDAQ: MSFT) at $29 price levels. Sure, Microsoft shares offer a dividend yield of 3.21%, which is much higher than IBM's yield. However, investors can buy more revenues per dollar from the S&P 500, since this index has a price-to-sales ratio of 1.32, while Microsoft has a much higher 3.28 ratio. By this measure it is more expensive than IBM. Microsoft shares are trading at a fair 14.32 price-to-earnings ratio, in line with the S&P 500 average and with IBM. Taken all together, IBM and Microsoft are about tied as income investments.
A better income investment is Intel, at $21 per share. This stock pays a hefty 4.23% dividend, which is more than twice the 1.82% 10-year treasury yield. Future dividend payments are likely because the company pays out 0.34 of earnings as dividends, so earnings could drop considerably before dividends must be cut. The firm does not have a weak balance sheet and carries a reasonable 0.15 debt-to-equity ratio, demonstrating that the firm is not over-leveraged.
Intel is also trading at appropriate price multiples given its future outlook. Intel shares are valued at a compelling 9.01 price-to-earnings ratio, a value which is significantly lower than the 14.23 average of the S&P 500. The firm's 1.95 price-to-sales ratio is in line with today's prevailing market multiples, which does not detract from its compelling price-to-earnings multiple.
Dell is arguably cheaper than Intel, but it is also riskier based on the problems facing its consumer laptop and desktop business. Shares of Dell are trading low enough at about $10 per share to compensate investors for the risks of a consumer computing company that is trying to transition into business solutions. Shares offer a dividend yield of 3.35% dividend. When compared to the 1.32 price-to-sales ratio of the S&P 500, the 0.27 ratio of this stock is very attractive. Dell shares are trading at a bargain 5.65 price-to-earnings ratio, less than half the 14.23 average price-to-earnings ratio of the S&P 500 index.
An even more speculative bet is Hewlett-Packard. At $14.50 per share it trades at a price-to-sales ratio of 0.23 and a 0.9 price-to-book multiple. Hewlett-Packard shares are trading at an incalculable price-to-earnings ratio (there was net loss for the last twelve months). A loss makes this firm look much less attractive than Dell, but Hewlett-Packard bulls may cite its 0.9 price-to-book multiple which is very attractive, much cheaper than the S&P 500's 2.07 average. The price-to-book ratio fails to account for internally-developed intellectual property including patents, brands, and trademarks. If the economic value of these assets were even partially recorded on the balance sheet the firm's price-to-book ratio would be even lower.
These incredibly low price multiples come with notable risks. Jim Chanos analyzed Hewlett-Packard as a short candidate, noting that Hewlett-Packard, like many computer companies, has been damaged by the Apple-led movement from personal computers to mobile devices. Chanos is concerned that Hewlett-Packard will go on a spending spree to acquire other companies in a desperate attempts to acquire lost market share.
Investors who seek exposure to business computing solutions should consider Intel as an attractive dividend stock and Dell as a more speculative investment. Intel trades at lower valuations than Oracle, IBM, and Microsoft. Dell is a safer bet than Hewlett-Packard, even though they trade at similar price-to-sales ratios.
Dive In, Investors
Intel's name is synonymous with the semiconductor, but savvy investors like yourself should constantly question whether there is a profit opportunity left from the stock. Thankfully, the Motley Fool has assembled a special report detailing the opportunity, risks, and Foolish bottom-line analysis on the company. Today, you can gain instant access to this report by simply clicking here now.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines, Intel, Microsoft, and Oracle. Motley Fool newsletter services recommend Dell, International Business Machines, 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.If you have questions about this post or the Fool’s blog network, click here for information.