Are These Two Tech Stocks Long-Term Winners?
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Global tech spending has been largely put on hold as a result of not only the fiscal cliff but also consumer uncertainty at large. But are they undervalued because of this weakness? For "buy-and-hold" investors, getting in at low prices now could pay off 10 years down the road when headwinds clear. Ironically, aggressive investors looking for the "perfect timing" will end up staying away from some of the more long-term winners because of the the short-term volatility. Below, I review two stocks in the tech market.
Accenture (NYSE: ACN): Pros and Cons
At a respective 17x and 14.3x past and forward earnings, Accenture is on the fairly expensive side in light of its historical 5-year average PE multiple of 15.3x. But some analysts, like Stifel Nicolaus, are still optimistic about the stock outperforming. In September 2012, the analyst boosted its price target from $69 to $76. Just a few days later, it upped it to $79, an 18% premium to the prevailing price. Over the last five years, free cash flow has increased by 54.5% to $3.3 billion (ttm), accelerating since 1Q11. This amounts to a yield of 6.1%, which is decent but not particularly good.
There are several reasons why I am on the fence about this management consultant and outsourcer. First, performance has been choppy. In the most recent quarter, revenue of $7.22 billion missed expectations by $70 million and grew only 2% y-o-y. Earnings are expected to only grow 5.6% next year, and, if anything, this may be too optimistic because the IT spending environment is uncertain. The poor business environment is reflected in Accenture's recent decision to downsize in Finland. Infosys, a major outsourcer, is also reporting weak demand from not just Europe and the United States but also China.
However, there are also several reasons to be optimistic. The company has taken steps to diversify through acquisitions. It recently purchased IPTV software assets from Siemens (NYSE: SI). Accenture will generate synergistic value through combining the business with Accenture Video Solution. A week later, on Oct. 9, the company announced that it had taken over avVenta, a digital production provider for ad agencies. This will be integrated with Accenture Interactive in yet another example of the company's focus on generating synergies. Lastly, it also has a significant net cash holding with $5.7 billion that can be used for accretive buyouts. So, from an M&A perspective, Accenture is in a good position.
Still, when you compare it to Siemens, Accenture has much less upside. Siemens is only valued at a 0.42x PEG ratio and is forecasted for strong double-digit EPS growth over the next five years. With a dividend yield of 3.6%, it also provides a stable stream of income.
IBM (NYSE: IBM): Not Undervalued but Still Good...
Billionaire value investor Warren Buffett famously invested in IBM, a decision that went against his typical aversion to tech companies for their "complexity." The reason for an investment is simple: It is expected to grow by a steady 9.9% rate over the next five years and provides a 1.8% dividend yield in the meantime. At 13.9x past earnings, the firm shouldn't see much margin compression, which is particularly evident by the 0.67 beta, a measure of volatility. If anything, there is room for considerable multiples expansion: Barclays and Stifel Nicolaus have price targets of $240 and $243, respectively. This translates to around 25% upside.
Over the twelve trailing months, IBM generated $16.6 billion in free cash flow, which is on a plateau against mid-2009 levels but amounts to a still decent 7.7% yield. Sterne Agree has listed the company amongst its top stock picks of 2013 and points to the company's unique business model in which 60% of earnings come from previous business. Acquisitions like flash storage provider Texas Memory and information lifecycle management software developer StoredIQ will help the company better service clients and boost this percentage even more.
From a risk/reward standpoint, I see little reason not to back IBM if your goal is to beat the market. Assuming expectations are met, 2016 EPS will come out to $22.13. At a multiple of 15x, this translates to a future stock value of $332, which provides for an average annual return of 16.3%. Combined with the company's stability, explained above, IBM is a "why not?" investment for buy-and-hold investors. On the other hand, it is not tremendously undervalued; at a 10% discount rate, the present value of the stock is only at a 7.1% premium to the prevailing price. So, IBM is ideal for the low-risk, steady growth investor.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines. Motley Fool newsletter services recommend Accenture Ltd. and International Business Machines. 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!