1 Tech Company To Buy, 1 Miner To Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Many investors prefer to lean toward one sector over the other. In my view, investors shouldn't fall in love with any one industry and instead diversify across the board. While many investors love gold, they can all too often become part of a cult and fail to look elsewhere where the fundamentals may be just as good--perhaps, better. To be sure, you should choose a portfolio that is overweight in an industry you are particularly bullish over others. Below, I consider the fundamentals of one tech company versus one metal miner. I recommend buying shares in both companies but more shares in CA.
CA (NASDAQ: CA)
CA is another attractive software producer that is trading well below intrinsic value. For a company geared for so much growth, the generous 3.9% dividend yield is nothing but a "bonus". Volatility is limited despite macro uncertainty. CA operates in enterprise IT management and appears undervalued on a multiples and fundamental basis.
On a multiples basis, CA is cheap against peers and historical levels. It trades at just a respective 13.3x and 9.4x past and forward earnings. The current PE multiple is only 79% of the historical 5-year average. Over the past 5 years, EPS has taken off like a rocket but just 10.3% annual growth is expected over the next 5. Assuming those expectations are met, the company will realize 2016 EPS of $3.59. At a 15x multiple, that translates to a future stock value of $53.91. Discounting backwards by a rate of 9% yields a present value of $35.03, which is at a substantial premium to the current valuation. Thus, CA has a considerable margin of safety.
On a fundamentals basis, CA also has multiple value drivers. The firm has basically gone nowhere over the past decade, but investors have failed to appreciate the catalysts. Revenues grew 7% in the latest quarter; management is targeting high-growth emerging markets, and investing in the SaaS platform for a competitive edge. Aggressive share buybacks further emphasize management's confidence over the fundamentals.
Rio Tinto (NYSE: RIO)
Rio Tinto is a high-risk metal miner worth considering. It trades at 5.7x forward earnings and a PEG ratio of 0.94 with a dividend yield of 3.1% and a beta of 1.7. According to data sourced from FINVIZ.com, analysts currently rate the stock a strong 1.7 out of 5 where "1" is a "buy", and the price target is $81.37.
The producer has significant exposure to inflation in Western Australia through iron ore and plans on increasing installed papacy by 30%, but diversification in several geographies helps reduce uncertainty (note, however, it is less diversified than peer BHP). Moreover, Rio's balance sheet is relatively healthy and CAPEX spending will fall over the next year to year and a half. Despite concerns over Asian headwinds, Chinese infrastructure is reportedly on the increase. For a company that is trading below its historical average multiple, the downside case is also fairly limited.
Aside from less diversification, Rio is distinguished from BHP Billiton (NYSE: BHP) by the former's lack of petroleum business and the presence of a much larger aluminum business. This is disappointing for the miner, since aluminum assets have been yielding poor returns and causing investor fatigue. During the second quarter, iron ore business, which represents 70% of EBIT, did really well in the sense that production rose 7%. Copper volumes also improved. But output in aluminum and alumina was poor with volumes falling 2% - missing expectations. Thus, while Rio is cheap on a multiples and growth perspective, risk preference will have to be balanced against the upside.
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