I published an article about Oracle (ORCL) on August 13, 2012. In that article, I suggested investors reduce long-equity exposure to Oracle. I was right: Oracle's share price declined on the fiscal cliff worries. That said, I apologize: I wasn't able to publish an article suggesting investors increase long-equity exposure.
In this report, I am going to lay out a case that answers the question, "buy, sell, or hold?" Over the long term, I should be able to forecast the share price of Oracle well enough for investors to achieve superior risk-adjusted returns.
To determine what we should do with shares of Oracle, we are going to take a look at the historic financial performance, operating segments and a fiscal 2013 forecast. We'll also compare Oracle's financial performance to salesforce.com's (CRM). Additionally, we'll value shares of Oracle, and we'll examine the share price from the perspective of a technical analyst.
Well, I think investors should reduce long-equity exposure to common equity shares of Oracle; Oracle is overvalued on an absolute basis and on a short-term relative basis. Next, we'll discuss the historic financial performance of the firm.
To add depth to the analysis of Oracle's current financial performance, we'll examine the financial performance since 2003. Financial performance is a cornerstone of equity analysis. The financial performance suggest Oracle is a growth firm and that shares of Oracle should be trading bullish.
Between fiscal 2003 and 2012, total revenue increased at an annual compound growth rate of 16 percent; however, the pace of growth prior to 2009 was faster than the pace of growth since 2009. Operating income increased at a 17 percent pace and net income increased at an 18 percent pace. The average basic shares outstanding declined at a 1 percent pace. That said, twelve trailing months revenue is roughly flat compared with 2012 revenue.
Oracle's pace of growth was roughly in the high teens. The growth rate was partly fueled by acquisitions. Regardless, the pace of growth is exceptional - especially for a company the size of Oracle. However, 4 percent revenue growth in 2012 and stagnant revenue through the first two quarters of fiscal 2013 could suggest growth is slowing.
Overall, the financial performance was stellar. Next, we'll compare Oracle's financial performance to salesforce.com's financial performance.
Oracle Vs. Salesforce
These two firms compete in some market segments. Thus, we'll compare the financial performance of the two firms. Oracle is the larger firm, but Salesforce is growing revenue at a much faster pace.
Between fiscal 2003 and 2013, Salesforce's total revenue increased sequentially every year at a compound annual rate of 51 percent; however, the pace of growth slowed after 2009. The firm generated operating income almost every year between 2004 and 2011; after 2011, operating income became an operating loss. In fiscal 2013, the operating loss swelled to $110 million. Net income attributable to common shareholders followed a similar pattern to that of operating income. Additionally, average basic shares outstanding increased at an annual pace of 18 percent between 2003 and 2013.
Salesforce is less than one-tenth the size of Oracle based on revenue. That said, Salesforce is growing revenue much faster than Oracle; however, Salesforce probably isn't as well managed as Oracle. The industry appears to be a high growth rate industry. In the next section, we'll cover Oracle's operating segments.
Oracle has three major operating segments. We'll discuss the recent financial performance of the operating segments to add depth to our analysis of the firm.
Between 2009 and 2012, software revenue increased at an annual pace of 11 percent. Hardware systems revenue declined 9 percent in 2012 compared to 2011. Service revenue increased 1 percent in 2012.
The software segment is the cornerstone and strength of the business. Oracle is trying to develop and grow the hardware segment; however, the firm continues to struggle in that area. The services segment is the most stable segment, and Oracle is probably betting that it is a slow and steady grower. Translation, the services and hardware segments are a drag on revenue growth from software; however, the additional product offerings have other benefits.
Overall, the product mix is solid: the firm offers software, hardware and service solutions. Next, we'll cover the 2013 forecasts.
Fiscal 2013 Forecasts
While Oracle is typically a fast growing firm, growth slowed last year, and I'm forecasting growth to slow or possibly turn negative in fiscal 2013. Next, we'll develop financial forecasts for 2013 to help create forward valuations.
I'm forecasting total revenue in the $36.4 billion to $38.2 billion range. Operating income should be in the $12.7 billion to $14.5 billion range. The net income range should be between $8.7 billion and $10.7 billion. Average basic shares outstanding should be 5 billion.
I'm forecasting -2 percent to 3 percent revenue growth. Based on the first two quarters, there is a chance that revenue may decline this year. However, Oracle has amazing leadership that may find a way to grow the business in fiscal 2013. Margins may also be slightly down to slightly up.
Revenue growth, if revenue does grow, should be in the low-single digits in fiscal 2013. Next, we'll discuss the forward multiplier model valuations.
In this section, we'll use the fiscal 2013 forecasts to create forward valuations. We'll use multiplier model valuations to value common equity shares of Oracle. Valuation is the heart of equity analysis.
I had a forward price-sales ratio between 4.69 and 4.93; the current share price used was $35.88. My current price-sales ratio was 4.83. I calculated a forward price-earnings ratio between 16.76 and 20.55.
Thus, on a forward price-sales and price-earnings basis, Oracle is overvalued. Also, on a short-term basis, the valuations are peaking. You could argue that the growth rate justifies the multiplies; however, the growth rate has slowed substantially and the multiples are still relatively high. Also, the firm is cyclical, and investors are paying a high price for cyclical earnings during an economic expansion. Typically, investors pay a low price for cyclical earnings during an economic expansion.
Common equity shares of Oracle are expensive. Next, we'll take a look at the chart to determine if this is a good location to sell shares.
Technical analysis adds another perspective to equity analysis; it allows us to manage practical risk. We'll use momentum and moving average studies to perform technical analysis of Oracle. Also, we'll briefly discuss Dow theory.
Common equity shares of Oracle are trading above the rising 50-day simple moving average: the intermediate-term trend is towards higher prices. However, the momentum indicators are forming negative divergences. Also, the trend of higher minor highs and higher minor lows may be about to reverse.
This is an excellent spot to liquidate some of your Oracle shares. However, we remain in a Dow theory bull market; any throwback may be short lived.
Oracle's financial performance has slowed, the valuations are stretched, and the technicals suggest liquidating a portion of your position; investors should reduce long-equity exposure to common equity shares of Oracle.
All of that said, further research should include more industry data, and the valuations should be updated.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.