3 Different Reasons to Buy 3 Different Tech Stocks

By David Gould - October 19, 2012 | Tickers: IBM, MSFT, ORCL | 0 Comments

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With the Street hot on technology, investors should consider buying stock in companies that are more than just hype. In fact, I find that some of the most attractive players are those that have been overshadowed by the likes of Apple. While some tech firms provide stability and safety, others offer high growth at a compelling price.

IBM (NYSE: IBM): Little More Than An Ideal Bank Account

Many value investors went cross-eyed when Warren Buffett parked a few billions into IBM. Buffett has acknowledged in the past that the growth of Berkshire Hathaway has forced him to spread more cash around into more expensive stocks. The benefit of limited capital is that you can get attractive returns from backing the most undervalued companies. Thus, IBM represented an attractive opportunity for Buffett to place some of his cash in a stable earnings growth machine.

IBM now trades at a respective 14.6x and 12x past and forward earnings, with a dividend yield of 1.7%. Earnings are expected to grow by 10.1% annually over the next 5 years, but they grew 16.6% annually during the past 5 - a period that included the global economic crisis. Accordingly, IBM could generate value creation through positive "earnings surprises."

However, IBM slumped 4% on Wednesday after a third quarter miss in revenue. Although top-line business in EMEA fell 9% due to FX headwinds, domestic business (which was not really affected by FX) also fell (by 4%). Sales in nearly all of the major segments were weak, especially in light of gross margins falling 3.6%. Moreover, IBM was weak on lowering corporate expenses, as revenue declined. This ultimately detracts from the company's image as a riskless stock that is heading nowhere but up. While some are optimistic about the company's leverage towards cloud computing, I see the company's drop in domestic demand during September as indicative of weakness in enterprise technology.

Microsoft (NASDAQ: MSFT) & Oracle (NASDAQ: ORCL) Both Undervalued

Warren Buffett has also said in the past that he would invest in Microsoft, but can't because his long-time philanthropic friend, Bill Gates, is affiliated with the company. In my view, Microsoft and Oracle are exceptionally undervalued software producers. The former trades at a respective 14.8x and 9x past and forward earnings, versus corresponding figures of 15.5x and 10.7x for the latter. 

However, Oracle merits its premium, since it is forecasted for 12.4% annual EPS growth over the next 5 years; that's around 350 bps more than what is expected for Microsoft. I still think that Microsoft is the safer of the two stocks due to its greater business diversification, near monopoly on the operating system for PC market, and leading 3.1% dividend yield. With double-digit ROA, ROE, and ROI, Microsoft is also compelling as a growth play.

Moreover, I find that Microsoft is better positioned over Oracle given that it is involved in consumer electronics and can thus appreciate off of reduced buying interest in Apple. As attractive as Apple is, it is overly expensive at 2.4x Microsoft's valuation. With the introduction of the Surface tablet that utilizes Windows 8, Microsoft is also taking a stab at the sustainability of Apple products. While 2Q 2012 may have been the company's first losing quarter since going public, the decline in EPS expectations from analysts has shown that they've forgotten about these long-term growth strategies.

All of this is not to say that Oracle is unattractive; in my view, it is undervalued. There are several reasons to be optimistic about the stock. First, customers in the database business face high switching costs, and thus are unlikely to defect to a competitor. In addition, the company has done a strong job integrating products to reduce operating costs and expand margins. With little debt, a multiple well below the historical 18.2x 5-year average, and free cash flow that has grown from $8.4 billion for the TTM ending 2Q 2010 to $13.1 billion two years later, Oracle has attractive fundamentals.

Compare and Contrast

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