2 Tech Stocks Too Cheap To Ignore

By Simon Erickson - August 28, 2012 | Tickers: AAPL, DELL, FB, HPQ | 0 Comments

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It's true.  Price matters.

The most important factor in our control as investors is the price that we pay when buying shares of a company. 

To demonstrate, let's take a look at one of the most successful tech stocks of the past decade:  Apple (NASDAQ: AAPL).  Even through the financial crisis madness, Apple continued to grow earnings year after year.  This provided astute investors with an opportunity to buy a great company on the cheap and amp their total investment returns:

*Based on Apple's closing price of $656 on 8/21/12.  Source of financial information: Morningstar.

Notice that even after growing earnings 36% year over year, Apple's stock price was slashed in half in 2008.  Investors that bought in December of that year were able to buy a growing business at a bargain.

How to Sniff Out a Bargain

There are several ways to determine what is "cheap" in the market.  The most universal way is to look at a stock's P/E Ratio, which compares the market price to the company's earnings.  For comparison to the market at-large, the current P/E ratio of the S&P 500 is 16.3.  Companies with a P/E ratio less than that are cheaper than the broader market.

But sometimes, company accountants like to get "creative" with earnings quality.  Revenue recognition, restructuring charges, and other one-time events can throw earnings out of whack with the reality of the income that is generated by business operations.  As such, many investors like to look at Free Cash Flow instead of earnings.  P/FCF is a metric that more represents price compared to the actual cash that is rolling into the business.

P/E and P/FCF are great metrics, but they both only consider the equity side of the equation (i.e. the market cap of all of the shares of stock of the company).  Many companies also issue debt as a way to raise money, and the lenders of this debt outrank stockholders in the pecking order.  Enterprise Value is the summation of all of the equity market capitalization of the company plus the company's long-term debt and liabilities.  Since we're now looking at all sources of cash raised for the company, we can use EBITDA as a proxy for cash flow of money that is coming into the business.  EBITDA stands for 'Earnings Before Interest, Taxes, Depreciation and Amortization", which removes the effects of how the company is capitalized.  EV/EBITDA will serve as our final valuation metric.

Two Cheap Tech Titans

Taking the above, boring accountant-speak into consideration, there are two technology companies with strong brands and long-term competitive advantages that are selling for dirt-cheap in the market right now.  For the fun of comparison, we can also look at a company that gets mentioned nightly at investor cocktail parties that carries a much loftier valuation (even after slightly adjusting in altitude lately).

Without further ado, here are those companies:

*Recent price based on closing price on 8/21/12.  Earnings based on previous year's reported results.  EV reported as Long-Term Debt + Other Long-Term Liabilities.  Source:  Morningstar.

Hewlett Packard (NYSE: HPQ) has lived and died by the hyper-competitive computer hardware business.  The company has suffered from declining margins and a revolving door in the CEO office.  However, there is still hope that HP can turn the corner.  Management has committed to avoid large-scale acquisitions in the future (after taking a hit for several writeoffs recently) and is focusing on improving its core business lines.  And it seems that all of the bad news is already baked in.  With a trailing P/E of less than 6 and EV/EBITDA below 5, the company doesn't have to reinvent the PC to meet analyst expectations. 

Dell (NASDAQ: DELL) has become an IT four-letter word, reserved only for use in the worst of situations.  The company was a pioneer is selling computers directly to consumers.  In 1992, Michael Dell was the youngest CEO of a Fortune 500 company.  But the dominance of all-things-Apple has wreaked havoc on Dell's operations and share price.  Dell shares are trading a further 6% lower today (not shown in the above price) after cutting their full-year guidance.  But even with all of the bad news, the company continues to survive.  They are growing their higher-margin enterprise services segment nicely -- which is a division that many suggest is the key to their future.  At a P/E of 6 and an EV/EBITDA under 4, any good news at all would be a lift to today's prices. 

And lastly, just to show where all the money is flooding, we can look at Facebook (NASDAQ: FB) for a quick comparison.  Facebook is down nearly 50% from its $38 IPO price, but it still sports an incredibly healthy valuation with a P/E that is SIX TIMES greater than HP or Dell!  Even though it is very young as a company and doesn't have the decades of operational experience, Facebook is clearly the market's fan-favorite and investors are willing to pay a premium to get in on the action.  Keep an eye on performance though.  Missing expectations at these levels could result in another drastic drop for the stock.

Foolish Bottom Line

The market is very clearly telling investors that some of the most established names in tech are yesterday's news.  At their current rock-bottom valuations, Hewlett Packard and Dell don't have to fire on all (or, even two) cylinders to provide investors with good returns at today's prices.

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