Tuesday, February 22, 2011

Time for Dividends in Techland

This Barron's article that five large tech companies including: Apple (AAPL), Microsoft (MSFT), Google (GOOG), Cisco (CSCO) and Intel (INTC) have net cash and securities equal to ~20% of their market cap. 

Many tech stocks financials are presented  using pro-forma earnings instead of those produced by generally accepted accounting principles (GAAP). Wall Street analysts will often do the same. The argument by management is usually that pro-forma is a better reflection of the company's economics.

Don't buy it.

This means the P/E calculated at most popular finance websites will look lower (i.e. due to inflated earnings) for those companies that follow this practice.

Cisco is one example. It looks cheap selling at 12 times current fiscal year earnings and even less including net cash. More from the article:

...those numbers don't include the $1 billion-plus—or 15 to 20 cents a share—that the company pays out to employees, through rewards of stock.

The article points out that most Street analysts will ignore this expense. It also mentions that Microsoft and Intel are examples of tech companies that do not follow this practice. They report GAAP earnings.

GAAP has its own limitations but pro-forma earnings isn't sufficient since stock-based compensation is material (especially for companies like Cisco and Google who use stock options extensively) and carries real costs for shareholders.

Here's a summary of the price to earnings excluding net cash for the following tech companies:

P/E Ex Net Cash
Apple: 12.9
Microsoft: 9.2
Google: 15.2
Cisco: 8.9
Intel: 9.0

There's a useful table at the end of the Barron's article that summarizes the price to earnings excluding net cash and other numbers for all the above tech companies (and some other tech companies).

So the above numbers provide a starting point. On the surface, each company looks reasonably valued or even cheap. In my view, Microsoft and Intel are examples of stocks that need little in the way of adjustments to get a clear picture of earnings.

Some others certainly do.

Depending on the amount of stock-based compensation those earnings adjustments can easily amount to 10-20% of lower earnings (and higher P/E).

Other adjustments may result in lower P/Es. Some argue that Yahoo!'s (YHOO) P/E is actually much lower than the one shown above when adjustments for cash and securities are made.*

There is a long list of other reasons why adjustments often need to be made to make the accounting more economically meaningful.

Unfortunately, there's no way around the fact that even when proper GAAP accounting is used it ends up only being a starting point.

Adam

Long Microsoft, Apple, Google, and Cisco

* The equity method in GAAP requires that the proportional earnings of an investment in a company's stock (or stocks) to flow through Yahoo!'s income statement. (Generally this method is applicable when ownership exceeds 20 percent but, as with just about everything in accounting, it's somewhat more complicated.) I've seen some examples when intrinsic value is being counted twice. For example: putting a multiple on the consolidated earnings -- including earnings from equity investments -- then adding the market value of equity investments. That's double counting.
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