Is customers' virtual boycott of desktop PCs in favor of touchscreen devices too great a hazard to Old Tech profits for even value-and-income minded investors to overlook?
After a double-digit plunge in first-quarter PC sales estimated by industry trackers IDC and Gartner Group this week, Goldman Sachs dropped Microsoft Corp. (MSFT) shares to a Sell rating Thursday, citing the weak outlook (so to speak) for PC sales and thus the company's Windows 8 operating system.
The stock sustained an immediate 3% loss, erasing its gains this week. Yet the fact that it still remains near where it finished last week suggests, perhaps tentatively, that no great growth from Windows 8 was built into its valuation or investor expectations.
And with the help of drugs, it’s becoming easier to see the value in old, boring technology stocks, despite the latest round of negative headlines.
The humdrum virtues
For comparison's sake: For most of the past decade, it was easy to find excuses not to own shares in Big Pharma. These vast companies – erstwhile growth-stock leaders of the ‘90s bull market – were no longer growing quickly, their innovation pipelines had thinned, they focused mostly on defending legacy products, and faster-moving biotech competitors threatened their dominance.
And yet some of the humdrum virtues of these mature, cash-rich pill pushers have lately become appreciated by investors chasing financially stable companies that promise generous and increasing dividend streams in a yield-starved, stability-craving financial landscape.
This hunt for bond-like clue-chip stocks has similarly led some investors to Old Tech, that collection of over-familiar, buzz-free stalwarts that rose to dominance in the era of PCs and Web 1.0. Like the drug makers, they are cash-flush, growth-challenged, legacy-protecting companies under assault, bit by byte, from younger, disruption-minded challengers.
Yet the five-month-strong market rally to new all-time highs has been paced less by the stocks of aggressive hyper-growth upstart companies than by the bond-like shares of utilities, real-estate trusts, cereal makers and slow-moving pharmaceutical makers.
Patrick Shallis, institutional broker at Gordon Haskett Capital, has closely tracked this rotation, noting that "the tape continues to 'locate' beaten down, left-for-dead, haven't-moved-in-years bond surrogates, with Microsoft, Intel (INTC) and GE (GE) being the latest discoveries."
The drug 'discovery'
Drug shares were "discovered" months ago. Since mid-November, the AMEX Pharmaceutical Index (^DRG) has gained 17.6%, ahead of the 16% rise in the Standard & Poor’s 500 index, not even counting the DRG’s dividend yield, which at the start of the rally exceeded 3.5%. Their profit pools seem reasonably defensible to many investors, and their management teams have gotten religion about prudent capital allocation and the sharing of cash with shareholders.
Yet companies such as Intel, Microsoft Corp., Cisco Systems Inc. (CSCO), Corning Inc. (GLW), and CA Inc. (CA) are survivors of a relentlessly deflationary, fast-evolving industry, with long-lived cash flows that should mitigate against rapid financial decline.
These attributes put this group in line to capture the next wave of attention and investor cash flowing toward stocks offering both participation in economic growth, the value of intellectual property and attractive cash yields. This column made the case near the start of the year that Old Tech was under-appreciated on the Street; it remains the case.
And, following the pharma sector’s steep outperformance lately, Old Tech looks a good deal cheaper by comparison.
The stocks in the DRG index trade for an average price-to-earnings multiple on the past year’s profits of 15.2, up from 12.8 in mid-November. Their average dividend yield has fallen to 3.1% from 3.7%. The ratio of their enterprise value (market capitalization minus net cash) to cash flow – a good measure of business value adjusted for cash and debt holdings – is now 9.4, up from 8.3 five months ago.
An Old Tech basket composed of Intel, Microsoft, Corning, Cisco, CA and even such a recent cult stock as Apple Inc. (AAPL) now fetches 10-times last year’s earnings and 8.7-times forecast profits over the next 12 months, carries a cash-flow multiple of 6.4 and a dividend yield of 3.0%.
These companies’ dividend payouts probably have more potential to grow quickly than those of drug stocks, given that Big Tech has only begin to focus on distributing its cash in a responsible way. Oracle Corp. (ORCL), for instance, still lags in its dividend policy, paying out only 15% of its profits for a current yield of only 0.7%. Over time, there is tremendous room for that to rise, whether under founder and current CEO Larry Ellison or the succeeding regime.
Of course, a sector’s relative cheapness is no secret to the market, and in itself doesn’t guarantee near-term investor returns. Microsoft and Intel settled into the hands of sober value investors years ago and still the stocks have gone sideways for the past three years.
Still, shares of Intel, Microsoft, Cisco and Oracle were up between 4.2% and 6.3% the first three days of this week alone, compared to a 2.2% gain in the S&P 500, before Thursday's setback.
One final caveat: Wall Street logic holds that, when the laggard stocks in a strong rally are finally scooped up and begin performing well, it can mean the bulls are running low on fresh ideas and are overreaching to put money to work. At times this can mean a rally phase is about to take a breather or retrench a bit.
There’s no handy way to tell if that’s the message we should be hearing from the recent perking up of lollygagging Old Tech. Or whether these stocks' low valuations repersent the market's firm verdict that they will be further marginalized for years to come.
But even if so, on a buy-and-hold basis, these stocks seem not to hold too much great financial peril or “headline risk,” and very few areas of this market combine high-quality financial characteristics with modest valuations the way these unexciting, mature computer giants do.