Unloved and Undervalued

by JR Robinson on October 30, 2013

Unloved and Undervalued- Are the tech growth giants of yesteryear a contrarian income/value play?

To be sure, this is no easy time to be investing. With interest rates hovering near historic lows, investor cash earns next to nothing and income- oriented investors face paltry yields and unprecedented risk in the bond market. At the same time, the U.S. stock market is trading near its all-time high. For the past couple of years, dividend stocks have filled the role of comfort food for many yield-starved investors. These days, however, with traditional rising dividend favorites, such as Johnson & Johnson, Coca-Cola, Kimberly Clark, and 3M, trading at around 20x earnings (i.e., at the high end of their traditional valuation levels) it is hard to make a compelling case that even these stalwart companies represent a good value.

So where can people who want/need more than a 0% return on cash turn to get their money working harder without doing anything too crazy or without “buying high”? One counter intuitive area that may merit consideration is the technology sector. While one does not typically think of tech stocks as being either conservative or income- oriented, a review of the financials of some of the largest and best-known tech names suggests that investors might do well to rethink their perceptions. For instance, companies such as Microsoft, Intel, IBM, and Cisco, all of which were leaders among the seemingly invincible high flying tech stocks of the 1990s (much like Google (GOOG) is today), have largely fallen out of favor since the tech bubble burst at the turn of the millennium. Because they are no longer able to grow their earnings at 20-30%+ per year, they have come to be viewed in the marketplace more as plodding behemoths than as sexy growth stocks. As a result, with the exception of IBM, the share prices of most of these companies have not gone up much over the past decade.

Being unloved is, in my opinion, part of what makes them attractive today. One point that seems to have been lost with respect to these companies is that slowing earnings growth rates are not the same as negative growth rates or losses. Despite their loss of stock market cachet, earnings at each of these four companies have continued to grow. Further, as they have matured, instead of plowing all of their earnings back into the company to fuel future growth, all four of these companies now pay out a portion of their earnings as dividends each year. In fact, all four appear to have established policies of raising their dividends each year and of raising them at a rate is much higher than the general rate of inflation. With all four sporting relatively low payout ratios (dividend/earnings per share), there appears to be ample room for future dividend increases as well.

In a word, these four companies seem cheap. While much of the large cap stock market is trading at close to 20x trailing earnings, at just 12-14x earnings, these for latter-day growth stocks are trading more like stodgy utility stocks. From a contrarian perspective, all four companies offer attractive current dividend yields, good prospects for dividend growth, and share prices that are reasonable relative to the rest of the stock market. In an environment where good values are hard to come by, I believe such unloved and undervalued companies may represent an oasis of opportunity in an otherwise barren investment landscape.

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*All data above has been obtained from Market Pulse as of 10/18/2013. While this data is believed to be reliable, its accuracy cannot be guaranteed.

 

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