Friday, January 21, 2011

Are Large Cap Tech Stocks Undervalued?

We've had quite a rally in the market, and are overdue for a correction, yet tech stocks like Apple (AAPL), and Microsoft (MSFT) all still seem reasonably valued these days*.

What a difference a decade makes.

The chart in this Minyanville article by Jeffrey Saut lays out by sector how much price-to-earnings (P/Es) have compressed in the past ten years. 

At the individual stock level it looks even more favorable.

Apple and Microsoft currently trade at a mid-to-low teens multiple of earnings. Both of those stocks look even more reasonably valued when you adjust for Apple's nearly $ 60 billion of net cash and Microsoft's over $ 30 billion of net cash.

In contrast, stocks like Amazon (AMZN), Salesforce.com (CRM), and Netflix (NFLX) currently sell at 40-50 multiples of earnings (in the case of Salesforce.com closer to 100x). So the sector P/Es don't tell you much.

It seems at least a bit odd that Apple could still be reasonably valued. Somehow the company continues to increase its earnings at a faster rate than what has been a high performing stock.

Apple should comfortably earn $ 20 billion for the fiscal year that will end in September.

Current market value of Apple is ~ $ 300 billion.

So it's selling for a 15x multiple of earnings.

Adjust for the net cash and investments of ~ $ 60 billion on the balance sheet and the multiple looks closer to 12x.

Is a company like Apple worth 12-15x its still rapidly growing earnings? It's tough to know with tech stocks, but seems a not expensive valuation given the company's prospects and specific risks.

Adam

I have small long positions in both Apple and Microsoft. The reason they are not larger positions? Because, in general, technology businesses reside in fast changing and unpredictable competitive landscapes. It's just that these businesses over the past couple of years sold at price levels in the market that provided a very large margin of safety in my view. So until the margin of safety shrinks I'm willing to have some exposure. Unlike shares in some of my favorite businesses (i.e. those in Stocks to Watch bought at the right price) these tech stocks are mostly NOT long-term investments.
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