A
significant portion of all the great advantages that the world has
received through the promise of technology can be credited to the Big 3:
Cisco Systems Inc. (CSCO), Intel Corp. (INTC) and Microsoft (MSFT).
Great gratitude should be attributed to these technology titans,
because, thanks to them, the world enjoys a functioning Internet and
enormous productivity advances.
Once
powerful growth stocks, they have all morphed into solid dividend
growth investments. Today, an equal investment in all three would
provide an above-average dividend yield of 3.37% with the potential for
double-digit growth. However, our bipolar business associate, Mr.
Market, who for so long lavished ludicrously high valuations upon them,
currently values them as though with disdain.
To
me there is a great absurdity in it all, where Mr. Market just can’t
seem to get valuation correct on the best of our blue-chip tech.
However, we should always keep in mind one of the important lessons that
Ben Graham attempted to teach us all. Ben Graham said, and I
paraphrase, that investors are neither right nor wrong because others
agree or disagree with them, they are right because their facts and
analysis are right. Ben Graham crystallized this message with his famous
Mr. Market metaphor courtesy of Wikipedia as follows:
“Graham's
favorite allegory is that of Mr. Market a fellow who turns up every day
at the stock holder's door offering to buy or sell his shares at a
different price. Usually, the price quoted by Mr. Market seems
plausible, but occasionally it is ridiculous. The investor is free to
either agree with his quoted price and trade with him, or to ignore him
completely. Mr. Market doesn't mind this, and will be back the following
day to quote another price. The point is that the investor should not
regard the whims of Mr. Market as determining the value of the shares
that the investor owns. He should profit from market folly rather than
participate in it. The investor is best off concentrating on the real
life performance of his companies and receiving dividends, rather than
being too concerned with Mr. Market's often irrational behavior.”
What
follows is a fundamental look indicating a trifecta bet on the
blue-chip technology titans, Cisco, Microsoft and Intel. Simply stated,
I believe the fundamentals indicate that all three are undervalued and
therefore, offer a margin of safety, above-average capital appreciation
potential with the sweet icing of an above-average and growing dividend
yield.
For
many years, investors were willing to buy these technology stalwarts
high only to sell them low later. In contrast, I believe the following F.A.S.T. Graphs™,
the fundamentals analyzer software tool, provide striking evidence that
the reverse is currently true. Currently, I believe that these
technology stalwarts can now be bought low with the opportunity to sell
high later, with the added benefits of above-average income and a margin
of safety.
Cisco Systems Inc.
Cisco
Systems has generated operating earnings growth of 12.7% per annum
since 1999. However, as previously stated, ludicrous overvaluation of
their shares by the bipolar Mr. Market diminished the investment value
of Cisco Systems’ strong operating history. However, now that price is
in alignment with earnings (the orange line on the graphs), future
shareholder returns should correlate with future business results.
There
is a secondary message regarding how misleading statistics can be, as
articulated by the normal PE ratio on the following Earnings and Price
Correlated Graph. Mathematically, or statistically speaking, the
historically normal PE ratio for Cisco Systems since the beginning of
1999 has been 40. However, from the graph it is clear that Cisco
Systems’ stock price has not been near a 40 PE since calendar year 2003.
Consequently, although the calculation is correct, it would be a
meaningless statistic if you got a spreadsheet. We will see the similar
anomalous PE relationship on Intel and Microsoft graphs.
The
blue line on the following graph shows that Cisco Systems’ PE ratio has
been in continuous descent since the irrational exuberant days of the
late 1990s. Although earnings have been growing, the PE ratio has been
shrinking due to overvaluation.
A
useful measure of valuation is the price to sales ratio. Relative to
its historical norms, the current price to sales ratio of Cisco Systems
is low. This indicates that the shares are currently attractively
valued.
When
the earnings and price relationship on Cisco Systems is viewed since
calendar year 2009, we discover that pricing has become more rational.
Moreover, we see the initiation of a dividend in fiscal 2011 (the light
blue shaded area) that is growing rapidly (see the light blue highlights
at the bottom of the graph). But most importantly, notice that Cisco
Systems’ stock price is currently below its earnings justified valuation
(the orange line).
Looking
to the future, we discover that the consensus of 39 analysts reporting
to Standard & Poor’s Capital IQ forecast five year earnings growth
of 10% per annum. Crosschecking with 10 analysts reporting to Zacks,
forecast five year earnings growth of 9.9%. Consequently, there appears
to be a strong consensus for above-average future earnings growth for
Cisco Systems.
Intel Corp.
The
Intel story is very similar to what was depicted on Cisco Systems
above. The big differences are that Intel is historically somewhat more
cyclical, but their dividend history much longer. However, I believe
the 4.1% dividend yield compensates investors for the more cyclical
nature of Intel.
As
we saw with Cisco Systems, the historical PE ratio of Intel has been in a
steady descent since the irrationally exuberant days of the late
1990s. Again, we discover that Intel went from being significantly
overvalued to being undervalued today.
The
current price to sales of 2.02 on Intel is one of the historically
lowest it has ever traded at. This is in spite of the fact that sales
have continued to grow.
Recent
earnings growth of Intel has been higher than their historical average
at 12.4% per annum since 2009. However, we once again see the more
cyclical nature of Intel’s operating history. Nevertheless, we think the
current low valuation compensates for the risk from cyclicality.
The
consensus of 18 analysts reporting to Standard & Poor’s Capital IQ
expect Intel to display a negative growth rate in earnings per share for
fiscal 2013. However, they expect earnings to grow again in fiscal
2014 and beyond at approximately 10% per annum. Consequently, Intel
appears very attractively priced today. Allow me to remind the reader
that the dividend has consistently increased each year in spite of the
cyclical nature of operating earnings.
Microsoft Corp.
Our
third and final example, Microsoft Corp., illustrates a continuation of
what we saw with our previous examples. Mr. Market had ridiculously
overvalued their shares during the tech bubble, which created a long and
tedious descent in share price as it reverted to the mean. Although
Microsoft had very strong operating results, the headwinds of
overvaluation destroyed any chance for attractive shareholder returns.
One
of the most important perspectives that the Microsoft example provides
is how there was such a separation between business results and stock
performance. Clearly, Microsoft, the business, performed exceptionally
well from 1999 until today. However, because the price was so insanely
overvalued, shareholder returns were poor in spite of strong operating
results. Finally, it’s interesting that strong operating results
generated a continuously increasing dividend.
The
following graph shows that Microsoft’s PE ratio has been in a
continuous decline since 1999. As the previous graph illustrated, it
went from being ridiculously overvalued to now becoming the exact
opposite. Microsfots’ stock price moved from the absurd to the sublime.
Along
with a falling stock price, Microsoft’s price to sales ratio has
continued to drop even though sales have grown. Therefore, Microsoft is
currently trading at one of the most attractive price to sales ratios
in its history.
When
the earnings and price relationship on Microsoft is viewed since
calendar year 2009, we discover that pricing has become more rational.
Moreover, we see a continuously rising dividend (the light blue shaded
area) that has been growing rapidly (see the light blue highlights at
the bottom of the graph). But most importantly, notice that Microsoft’s
stock price is currently below its earnings justified valuation (the
orange line).
Like
the two examples before it, Microsoft is expected to grow at
above-average rates going forward. A consensus of 35 analysts reporting
to Standard & Poor’s Capital IQ forecast 3% earnings growth for
fiscal 2013 before accelerating to a 10% growth rate over the next five
years. Assuming these estimates are correct, Microsoft shares provide
the potential for significant capital appreciation and a growing
dividend income stream.
Buying low in order to sell higher is the first, and perhaps the most important rule of investing. However, human nature being what it is, it also seems to be one of the most difficult of all investing rules to follow. I can remember warning people about how dangerously overvalued the Big 3 - Cisco, Intel and Microsoft were during the tech bubble spanning the mid-90s until early 2000. At that time, I was literally called a dinosaur, told that I did not understand the new paradigm, and my favorite, that valuation didn’t matter anymore.
Those who failed to heed my warnings and aggressively invested in tech lost substantial amounts of money due to their foolish behavior. I believe a similar situation exists today, only in reverse. These great, once high-flying technology growth stocks have now morphed into undervalued blue-chip dividend growth stocks. But once again, we discover that our bipolar partner Mr. Market is choosing to ignore fundamental values by pricing these blue chips significantly below their intrinsic value. As Ben Graham taught Warren Buffett and as Warren Buffett has tried to teach us, exploit other’s folly, don’t participate in it.
Disclosure: Long CSCO, INTC and MSFT at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
