VALUE ADDED


Ten Tech Giants to Buy Now

Steven Goldberg

Shares of companies such as IBM, Nokia and Microsoft have taken a hit along with the rest of the market, but they don't deserve to be this cheap.



As Benjamin Graham observed many decades ago, the stock market is manic-depressive -- ebullient one day, despondent the next. Technology, however, suffers even wider mood swings than the rest of the market.

Today, tech, particularly the largest tech companies, looks cheap -- and compelling.

Almost everyone remembers the late 1990s, when price-earnings ratios on many tech stocks surged into triple digits. Investors bid Internet stocks with no earnings and no sales to breathtakingly high prices based on how many computer users were clicking on the company's Web sites. "Price to eyeballs" was the popular metric.

That folly ended disastrously, with an 80% decline in the Nasdaq Composite Index. The tech-heavy benchmark is still less than half of its early-2000 high of more than 5,000.

But look at the valuations on the ten biggest tech companies today. The average tech titan trades at just 19 times the previous 12 months' earnings per share, according to the Leuthold Group, a Minneapolis-based investment-research and money-management firm. That's the lowest average P/E recorded for the tech giants since early 1992. The average price-to-cash flow for the group is a similarly low 12.5. (Cash flow is earnings per share plus depreciation and other non-cash charges.)

Advertisement

On free cash flow yield, the ten tech giants really look like giants. The average mega-cap tech stock has a free cash flow yield of 6%, Leuthold says. That's the highest level in more than 20 years. (Free cash flow is cash flow minus the capital expenditures needed to maintain the business from cash flow. Divide free cash flow by shares outstanding to get free cash flow per share, then divide the resulting figure by the share price.)

Bottom line: These companies are cheap, but so are a lot of bank stocks. The important question is, Do the tech stocks deserve to be this cheap? The answer is a resounding no -- even though tech stocks have sold off with the rest of the market this year.

On average, brokerage analysts estimate that the earnings of the tech giants will grow by 17% annually over the next three to five years. Even as the economy weakens, many large tech companies have been reporting solid earnings.

A key reason: Many of their customers put off spending on technology for years as they worked to strengthen their balance sheets. But that trend has reversed. "Companies are continuing to invest in technology to reduce costs and enhance their information-technology infrastructures," Morningstar analyst Rick Hana wrote in a recent report.

Perhaps even more important, many of the tech giants have developed dominant and stable franchises. That's a sea change from a decade or so ago, when start-ups continually unveiled products and services that undermined the established players.

So why is tech so cheap? Part of the reason, I believe, is that so many investors, including professionals, still carry scars from the horrendous tech bear market. It's awfully hard to buy a stock -- or even a sector -- that has previously caused you so much pain.

Below are thumbnail descriptions of the tech top ten. Use them as starting points for your own research. Vanguard Information Technology ETF (symbol VGT) offers many of these stocks, and more, at an expense ratio of just 0.22% annually. As with any sector bet, don't overdo it.

Practically everything Apple (AAPL) has touched in recent years has turned to gold, from the iPod to the iPhone to its retail stores. The biggest question mark is chief executive Steve Jobs's health. Not surprisingly, this is the most richly priced behemoth. At an August 5 closing price of $160.64, the stock trades at 31 times estimated calendar 2008 profits of $5.26 per share, according to Thomson Financial (Apple's fiscal year ends in September). Analysts see earnings growing 22% annually over the next three to five years. The stock is volatile but has shown little change since last fall.

Cisco Systems (CSCO) dominates practically every networking area in which it competes. What's more, it continues to acquire fast-growing companies. Yet, at $22.65, down from $34 last fall, Cisco trades at just 15 times estimated earnings of $1.56 per share for the 12 months ending next January 1 (Cisco's fiscal year ends in July). Analysts anticipate annual earnings growth of 15% over the coming three to five years.

Along with Apple, Google (GOOG) gets the most buzz of the big ten. At $479.85, it trades at 24 times estimated 2008 earnings of $19.71 per share (thankfully, it's a company with a normal fiscal year). But the search and advertising giant is also the fastest-growing. Analysts estimate that its profits will climb 30% annually over the next three to five years. The stock has lost 7% since last fall.

Hewlett Packard (HPQ) is one of the cheapest of the tech ten. At $45.50, it trades at just 12 times estimated earnings of $3.66 for the 12-month period that ends this January (HP's fiscal year ends in October). The company sells information-technology services, products and hardware to businesses and consumers. Its heft should increase once it completes the acquisition of Electronic Data Systems (EDS). Analysts expect earnings to grow 14% annually over the next three to five years.

IBM (IBM) has such a breadth and depth of products that many companies turn to it first-for IT hardware, software, services, or all three. It has bucked the stock-market selloff, closing at $128.87, near its all-time high. But that's just 15 times estimated 2008 earnings of $8.81 per share. Brokerage analysts anticipate 10% yearly earnings growth over the next three to five years.

Just as Cisco dominates networking, Intel (INTC) rules microprocessors. At $23.02, Intel trades at 18 times estimated earnings of $1.28 per share. Analysts estimate earnings will rise 15% annually over the next three to five years.

The company everybody loves to hate, Microsoft (MSFT) continues to be the dominant platform for PCs. Yet, at a price of $26.21, it trades at just 13 times estimated calendar '08 earnings of $1.97 per share (Microsoft is on a June fiscal year) and yields 1.7%. Future estimated earnings growth is 12% annually. As its failed bid for Yahoo indicates, Microsoft has been struggling to expand its presence on the Web. The stock is nearly 60% below its record high, set in 1999.

The world's largest handset maker, Nokia (NOK), boasts efficiencies that its competitors only dream about. Its share of the market should continue to grow. Yet the stock, at $27.79, trades at a bargain price of just 11 times estimated 2008 earnings of $2.48 per share. Brokerage analysts predict that the Finland-based company will generate long-term earnings growth of 12% a year.

Oracle (ORCL) is the leading player in database software, with much of its revenue coming from software license renewals and product support. Yet the stock, which closed at $22.21, sells at a thrifty 16 times estimated earnings of $1.39 per share for the year that ends in November (Oracle's fiscal year ends in May). Earnings are projected to grow 15% annually.

What Nokia is to handsets, Qualcomm (QCOM) is to cell-phone technology -- and then some. It's the biggest provider of software and semiconductors for cell phones. The recent settlement of a long-running patent feud with Nokia should help both companies. At $55.73, Qualcomm trades at 24 times estimated calendar 2008 earnings of $2.32 per share (the company's fiscal year ends in September). Earnings are expected to increase 20% annually.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.



Get Value Added by e-mail for FREE. Registered users on Kiplinger.com can sign up to receive more than 20 valuable updates. Register Now »


More Sponsored Links


DISCUSS

Permission to post your comment is assumed when you submit it. The name you provide will be used to identify your post, and NOT your e-mail address. We reserve the right to excerpt or edit any posted comments for clarity, appropriateness, civility, and relevance to the topic.
View our full privacy policy


Advertisement

Market Update

Advertisement

Featured Videos From Kiplinger