Saturday, April 16, 2011

Cheap Electronics


Technology changes fast, so fast in fact, that some famous value investors avoid it completely.

Warren Buffett has said that he prefers companies like Coca-Cola because they are easier to value:

"It's very easy for me to come to a conclusion as to what Coke will look like economically in five or 10 years, and it's not easy for me to come to a conclusion about Apple"

Buffett couldn't be more right, valuing technology companies is difficult. However, investing is an odds game, nothing is 100%. You just want to take bets that are heavily weighted in your favor. As Mohnish Pabrai puts it, the ideal investment is one where:

Heads, I win; Tails, I don't lose much.

A number of large tech companies are getting to the point where I feel, I might make a lot or not lose much. (check out barel karsan for more detailed write ups on some of the companies below)

The stocks below haven't moved much in the past 5, or sometimes 10 years, but all have had great earnings growth. This has led to falling PE ratios and the stocks to appear cheap.

Also, all of the companies have solid balance sheets. In particular, Cisco and Microsoft have massive cash balances (although most is overseas.)

10 year Average PE Forward PE
cisco 24 13.5
microsoft 22 9.9
hp 17 7.7
rim 36 7.7
dell 28 8.9

However, each company has a separate set of complicated problems that may cause them to be 'value traps':

Cisco: A shift to virtualization, cloud computing, fierce competition (HP & Juniper), aggressive growth targets (12-17%) causing poor acquisitions.

Microsoft: A shift to tablets and mobile platforms (Android), consistent failure to enter new markets in a meaningful way (Zune!, Windows Mobile).

Dell & HP: Fiercely competitive commodity industry (PC assembly), poor long term prospects in printing (HP printer & ink sales), record high operating margins at HP (are they sustainable?)

RIM: Consistently out of date products (The Storm, The Torch), poor ability to innovate and expand its product line (The Playbook looks awful.)

Finally, all of the above companies face unknown shifts in technology. As Charlie Munger puts it:

"Acknowledging what you don’t know is the dawning of wisdom."

And technology is an area where I, or even the best analyst, will never know what the future will look like. But at single digit PEs, I feel the downside is limited.

Although there are risks, there are also strengths. Cisco has a dominant market share that provides a competitive advantage and management appears to be rationalizing its business areas. Microsoft still dominates the PC industry and is finding success with its core products. HP and Dell have been expanding into high margin services and have extremely low PE ratios. Rim has a loyal following of blackberry users, strong security reputation which is valuable to corporations and great international growth. 

The long term earnings and valuation may be difficult to estimate, but these tech stocks appear to be priced for a worst case scenario.

Seems like a good bet to me.

Disclosure: Long CSCO, MSFT.
Update: Sold CSCO, MSFT.  (see my post just before selling MSFT)

Disclaimer: The content contained in this website represents only the opinions of its author(s). We, or clients we advise, may hold long or short positions in securities mentioned in the website. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision.


hardcore value said...

Tilson on Microsoft & Apple
Reuters April 21, 2011

One of those less favored companies set to report next week is Microsoft. The company suffers from a reputation for slow growth and its price at nearly 11 times current earnings clearly reflects that.

Comparing Microsoft to Apple, Tilson says that the former is an inherently better business as it is focused on software with marginal incremental production costs compared to Apple's consumer hardware business.

Apple is "a fabulous business, but I'm simply pointing out that you can own a better business, albeit one that is not growing as quickly -- but still growing nicely -- for half the price in terms of price-to-earnings multiple," Tilson said.

hardcore value said...

After Friday's selloff, Microsoft is trading at 7.1 times expected fiscal 2012 earnings, excluding cash.

hardcore value said...

Wow terrible guidance from RIM, the bear case is winning!

I've written my thoughts about why I passed (and am still passing on RIM for now) in the forum.

Anonymous said...

Why Intel is not in the list ?

Intel looks better than all the 5 names in your list.

etech said...

I had the same type of experience. I purchased the same model and had it working immediately. I can not ever imagine going back to a laptop. I particularly liked your observation that we need to conform to the laptop while the iPad follows our posture - it is so intuitive. Great comments! Thanks

Arriana Jane Calderon said...

This is really interesting information. Thanks for posting.

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