So far in 2011, technology is among the worst-performing industries in the market. The stock market, as measured by the S&P 500, ended the first quarter up nearly 6%, while tech returned just over 3%. Additionally, the average price-to-earnings (P/E) ratio for the stock market is around 14, while many leading tech companies trade well below this level -- some even trade with single-digit earnings multiples. With weak near-term performance and low valuations, I see a contrarian buying opportunity.
By the P/E metric alone, the tech sector is cheap. However, tech may be even cheaper than you think. This is because many of the leading players in the industry have managed to sock away billions of dollars in excess cash not needed to run daily operations. From a valuation perspective, it has become necessary to back out these net cash positions to focus solely on the underlying operations.
Below is a table detailing share price and fundamental data for five of the largest tech companies out there. As you can see, the stated P/E ratios, which are simply the latest stock price divided by earnings throughout the past 12 months, are pretty reasonable.
Apple (Nasdaq: AAPL) sports the highest P/E figure at nearly 19.5, but this is still reasonable given the fact it has managed to grow earnings at nearly 57% annually in the past three years. It is even arguable that the stock is cheap on an earnings basis given this stellar growth, though the company will likely find it tough to continue to grow at such a rapid pace in the coming five years.
Based on the stated P/E ratios, the rest of the names in the table are bargains in my mind, given the low earnings multiples. These firms remain leaders in their space and have above-average growth prospects. But better yet, these firms have quite a bit of excess cash that can be backed out of the P/E calculation. The math is straightforward:cash per share is simply subtracted from the stated stock price.
Backing out this net cash, Apple is more reasonably valued at less than 18 time earnings ($348.51 - $29.29 = $319.22; $319.22 / $17.92 = 17.8). After doing the math for the other stocks in the table, the other four now trade at less than 10 times earnings and are even cheaper. Dell (Nasdaq: DELL) is the cheapest, at about 7.5 times earnings and is being valued as if investors expect the firm to never grow earnings again. I recently suggestedDell's share price can rise 50% from current levels and firmly believe this still to be the case.
I've also profiled Cisco (Nasdaq: CSCO) as the best tech stock money can buy, given its low valuation and leadership position in products that form the backbone for growing Internet data. I think worries over near-term market share losses are something to watch carefully, but are unlikely to derail its dominance in routers and switches. I also think new consumer products could end up as profit drivers.
Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) are also compelling, given their dominance in computer software and semiconductors, respectively. Both firms have generated tens of billions of dollars in excess cash that is being used to shore up competitiveness in other growing areas in tech, including smartphone software and the chips that are used to run them. At less than 10 times an adjusted P/E basis, I see little downside risk to owning the names over the next several years.
-> I am convinced that the largest firms in the technology industry remain significantly undervalued and that most investors are missing just how undervalued they are by looking only at stated P/E ratios in the market. Billions in excess cash demonstrate just how dominant these firms are and what their underlying operations are capable of generating in terms of cash flow.
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