They are stable, inexpensive, sober sources of income -- boring, even. They are the big “old tech” stocks, more than a dozen years since their youthful, volatile, growth-drunk peak.
The surviving giants of the PC revolution and Web 1.0, such as Intel Corp. (INTC), Microsoft Corp. (MSFT), Cisco Systems Inc. (CSCO) and Dell Inc. (DELL), long ago surrendered their hold on consumers’ sense of wonder and investors’ zeal for growth and excitement.
Those four "old tech" leaders, of course, are synonymous with the “Wintel” PC economy, which is enormous yet threatened by the ascendance of mobile devices and more-flexible computing architecture. Of course, each is maneuvering to parlay its legacy advantages to participate fully in the newer go-everywhere Web. But they are so big and dependent on their installed base of machines that little confidence exists in their ability to keep up.
As a result, their stocks are cheap and “under-owned,” their management teams are sharing their lush cash flows through healthy and growing dividends and the companies suffer what George W. Bush once called “the soft bigotry of low expectations.”
An "old tech" bargain?
Intel, Microsoft, Cisco and Dell trade at an average multiple of just over 9-times forecast profits for the coming year, compared to about 13-times for the broad market. It’s understandable that these tech leaders of yesteryear would appear cheap given the perceived secular challenges to their primacy. Not to mention the fact that Apple Inc. (AAPL) – with its new-product dominance and cult following – trades only at about 10.6-times expected 2013 earnings.
On another, better valuation measure, "old tech" looks like an even clearer bargain. Their enterprise value (market value minus net cash) divided by cash flow for the past year averages to a multiple of five. Apple, inexpensive as it clearly is, has an EV/cash flow multiple of 8, which gives full credit for its $100 billion-plus in cash hoard.
Still, the "old tech" group remains impressively profitable, with returns on equity far in excess of the typical company, and their cash-rich balance sheets afford them great flexibility to increase dividends and buy back shares.
For these reasons and others, "old tech" names are surfacing with some frequency across a number of stock-selection methods at the start of the year.
The risk-reward tradeoff
Among the segments of the market that appear to offer a decent risk-reward tradeoff based on valuation and investor sentiment are mega-cap stocks; businesses with stable, high-quality finances; globally exposed firms and those with the potential to ramp up their dividend payouts over time.
"Old tech" pretty much ticks off each of those boxes. Savita Subramanian, equity and quantitative strategist at Bank of America Merrill Lynch, recommends what she has called “big-cap, old-fashioned technology” for this potentially winning combination. And while the long-term growth worries can’t be dismissed, she also notes that tech companies face less risk to their earnings than they have throughout history, having seen the largest drop in the volatility of their results of any sector since 2006.
Goldman Sachs strategists, cutting at a different angle, favor companies with a high likelihood of meeting earnings projections, combined with strong quantitatively derived risk-adjusted stock appreciation potential assuming they do. This screen plucked out Microsoft as well as "old tech" counterparts International Business machines Corp. (IBM) and Automatic Data Processing Inc. (ADP).
The big money moves on
The big money, in general, has moved on from these ‘90s sensations. The top three institutional shareholders of each Intel, Microsoft and Cisco are passive, index-fund managers -- often a good sign, by contrarian logic, that few stock pickers expect much of them.
There is no doubt these stocks have seemed inexpensive for a while -- and indeed they’ve done nothing but get cheaper as they have underperformed the Standard & Poor’s 500 index over the past five years.
In this respect, they might be viewed as a sort of optimist’s bond substitute: providers of more income than the broad market delivers, with good balance-sheet support to their share prices and no more volatility than the average stock. Intel, Microsoft, Cisco and Dell have an average dividend yield of 3.3%.
The stability factor
Bought as a basket, such stocks would not likely lead in an exuberant stock market but will probably be stable and throw off decent cash income. And they will at least have the chance of getting a lift as money rotates toward mega-caps or on renewed enthusiasm about overall tech spending.
In some respects this subsector resembles Big Pharma stocks, with their stout balance sheets, good cash yields and slow-growth outlooks. The stocks can stay cheap or start to act like “value traps” by getting even cheaper. Or they can gain favor as Pfizer Inc. (PFE) has, rising 40% over the past two years, with little profit growth.
Intel, in particular, is fascinating, not as much for its 4.4% yield but for the company’s amazing ability to achieve excellent returns on capital while massively increasing production capacity, pouring billions a year into R&D and operating for 40 years in a market of relentless price deflation for its products.
Operating income doubled in the five years since 2007 and, having recently fattened its R&D budget as it chases mobile-device dominance, the company is acting like anything but a cash cow as CEO Paul Ottelini prepares to retire in May. In some ways, Intel and its semiconductor competitors behave more like traditional industrial stocks these days, so integral are their components in every part of the world economy. Even by those standards, Intel is better-run and more modestly valued than the run-of-the-mill big industrial.
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