Sony Corp (NYSE: SNE) has long been regarded as the leading Japanese hardware company given its rich heritage as a high-quality TV maker and creator of the hugely popular PlayStation console. Meanwhile, Lenovo Group Ltd (SEHK: 992) is one of China's top hardware tech companies given its dominance in the PC business.
Given that both companies trade at relatively low valuations, which stock is the better buy at the moment for investors?
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In terms of secular trends, Sony might face difficulty with its cash cow, PlayStation, in the next decade. Although the console is a leading platform with network effects, it could face disruption due to the emergence of 5G cloud gaming.
Many believe 5G cloud gaming will mean PlayStation games are possible on mobile phones or other portable computing devices. Due to 5G's fast speed and low latency, most of the heavy lifting in terms of game processing can be done in the cloud, and the graphics and audio can be transmitted to mobile devices wirelessly.
In terms of how much of a negative effect 5G cloud gaming will have the PlayStation's sales, Wedbush Securities analyst Michael Pachter predicts that "every console generation going forward will be about half as big as the one before it".
Given that Sony gets around 43% of its earnings from the flagship console and its associated services and products, a 50% decrease in PlayStation revenues could substantially impact Sony's bottom line.
Lenovo, on the other hand, doesn't face secular disruption for its key product, the desktop computer. While the desktop might change over time, there will likely be steady demand for it as there isn't a viable replacement any time soon.
Besides the desktop, Lenovo stands to benefit from the secular trend of the growth of data centres and the Internet of Things (IoT) where the company has strong exposure.
Due to the trade tensions and the slowing Chinese economy, the Chinese RMB has depreciated meaningfully lately. The depreciation is negative for companies with more China exposure as it lowers earnings in dollar terms and Lenovo doesn't do as well as Sony in that regard.
For 2018, 25% of Lenovo's US$45.35 billion sales came from China. Meanwhile, just under 9% of Sony's sales came from China for the 2019 fiscal year ended 31 March.
In terms of valuation, both Sony and Lenovo are cheap. Sony currently trades at a forward price-to-earnings (PE) ratio of 13.1 and, according to the hedge fund Third Point, has potential upside of around 80%.
In a public letter, Third Point writes that Sony's low valuation is due to a "conglomerate discount" where investors discount valuation due to challenges in terms of forecasting the numerous future business drivers. To try to increase Sony's valuation, Third Point believes management should sell some of its stakes in publicly listed companies that Sony owns and buy back a lot of stock.
Third Point also believes management should spin off the company's smartphone image sensor division that powers digital cameras. The division has over 70% market share and could be worth a lot more as a stand-alone entity.
Meanwhile, Lenovo trades for a forward PE ratio of 11.4 and has a price target of HK$7.50 per share according to Verena Jeng of Goldman Sachs. Given Lenovo's current price, the stock has 46% upside.
Although Sony has higher upside potential and has less China exposure, Lenovo is arguably better-positioned in the long run due to its exposure to the datacenter and cloud.
Meanwhile, Sony might have a hard time adjusting when cloud gaming becomes more popular. Although the short-term winner might be Sony, I believe the long-term winner could very well be Lenovo.
A version of this article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.
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