5 Dead Money Plays in Technology

|
 |  Includes: AAPL, CSCO, HP, INTC, MSFT
by: EconMatters
There are some distinct trends in technology stocks that are worth pointing out to investors. Namely, there are a set of tech companies that become investing wastelands for investors looking to build above average returns for their portfolio.
These are not bad companies, in fact, they make great products and provide excellent services, but from an investing standpoint they have become dead money. These are stocks that are stuck in a continual narrow trading range for an extended amount of time, and do not make up for this defect with above average dividends for shareholders, so from an investment standpoint they should be avoided as serious candidates for one's portfolio.
There are ways to play these names, and many professional investors do just that -- by buying the stocks at the low end of their respective trading ranges and selling at the top of their ranges. This is a form of relative value trading which sophisticated players have successfully executed over the years for solid relatively low risk returns. But retail investors who buy these stocks and hold them in their portfolio -- just because they are great companies with great products -- have been severely disappointed over the years.
Microsoft (NASDAQ:MSFT)
Let's get started with Microsoft, a great company with excellent profits over the years but the stock has just languished as an investment vehicle for the last decade. An investor who bought MSFT back in 2001 for $30 a share is actually experiencing a loss in the stock at the current price of $24.50 a share.
The firm has raised its dividend over the years, but not nearly enough to compensate for loss on the stock, devaluation of the U.S. Dollar, and inflation over the same period of time. The dividend currently stands at 64 cents for an annual yield of 2.6%.
If you are a dividend investor there are better places to park your money with relatively equal risk. Think in terms of Verizon (NYSE:VZ), with a 5.2 % annual dividend yield. Microsoft could significantly raise its dividend in the future, but with the recent Skype acquisition, and reluctance to be classified as a “Slow growth non-innovator”, this seems highly unlikely over the next five years.

Click to enlarge
There are some key levels where it makes sense to invest in MSFT, and I imagine this is the strategy of certain value investors like Whitney Tilson, who has been an advocate of this stock over the past eight months. However, be cautious that you are getting in at the right level, and not buying his value at the top of the trading range.
The stock has been declining lately, and is pretty decently priced given its decade long trading range (See Chart), but it will become even cheaper over the summer. There is near term weakness due to the expensive Skype acquisition, the annual summer technology selloff, and further weakness due to the culmination of QE2. These factors suggest a high probability that MSFT could be acquired near the $22 a share level sometime this summer. So wait for the price to drop near the $22 a share level, anything under $22 has proven to be a nice value price for owning Microsoft over the last 10 years.

Intel (NASDAQ:INTC)
The next company that fits nicely in this category is Intel, another strong company with solid profits over the past decade, but not a stock to brag about in one's portfolio. Intel traded around $30 a share in 2001 and is currently trading at $23 a share, a $7 a share loss for your investment in the company over this time period if an investor just bought and held this stock in his / her portfolio.
The share price loss is offset by a 72 cent dividend which comes out to an annual yield of 3.1%, but remember INTC`s dividend in 2003 was only 8 cents, so when you factor in inflation and currency devaluation implications, an investment in Intel over the past decade has been a losing proposition.
Click to enlarge
I like the fact that INTC has been steadily raising its dividend over the last eight years, but until the dividend gets above 4%, there are equally safe places to seek higher dividend returns for one's portfolio-- like AT&T (NYSE: T), which pays a nice $1.72 dividend for a 5.5% annual yield.
Again, there are some key price levels where investing in INTC makes for an excellent value proposition, and the patient investor has successfully acquired Intel around the $18 a share level on numerous occasions over the last decade.
I would say that with the increasing dividend, $19 a share is a practical level to add this company to one's portfolio, and keep in mind that the stock has traded below or near $19 a share three times over the past year. I would not be buying Intel at these levels-- even though it can go higher from here-- because the only price that makes long-term sense given its historical price is around $19 a share.

The best way, and only rational investing strategy for playing these dead money technology stocks over the past 10 years is to be extremely patient and buy only when a nice relative value opportunity presents itself.
I think the market in general-- and specifically technology , which has outperformed during QE2-- will correct significantly over the next four months. Given this thesis, there should be an opportunity to purchase Intel sometime over the next four months around $19 a share. If the opportunity doesn't occur this summer, just remain patient as another buying opportunity will surely present itself given the stock's price history.
Cisco Systems, Inc (NASDAQ:CSCO)
We next turn to Cisco Systems, Inc. which has had its share of problems lately, routinely missing quarterly expectations for the past year, but is another company with an excellent track record for consistent profits over the past 10 years. The only problem is that shareholders haven`t been rewarded for holding this company`s stock in their portfolio. In fact, an investor who purchased Cisco for $19 a share back in 2001 can now buy those same shares back for $16.50 today, and an investor isn`t going to retire comfortably on those returns.
The stock has had its moments, having traded as high as $33 a share in 2007, for instance. But for the most part, the stock has languished around $20 a share for the past decade. Cisco pays a paltry 24 cent dividend for an annual return of 1.4%, so shareholders cannot offset their losses by claiming significant dividend returns.

Click to enlarge
It is a relatively safe store of value, although that may even be in question as of late given the company's restructuring strategy that is in mid stream development. But again, there are better alternatives with an equal risk profile, but much better dividend returns for the conservative investor like Exelon Corp. (NYSE:EXC) in the utility sector, which pays a nice $2.10 dividend for an annual rate of 5% and is significantly higher than it was in 2001 as a stock.
There are some prices and valuation levels that make Cisco an attractive risk / reward play. But given the recent weakness in the stock, and performance over the past year in a QE2 inflated environment, the value investor needs to wait for much lower levels than previously.
A good level to start looking at CSCO would be around the $14 a share level, and I would average into the position, as the potential for another poor earnings report combined with a significant summer selloff in technology could send the stock to the $13 a share level. Remember, when stocks become directional, they often go lower or higher than one would think possible beforehand. Right now Cisco is on a directional downtrend.
If you are a believer that they can turn the company around, and the worst is being priced in then an investor might want to start averaging into a long-term position at the $15 a share level. But be cautious as technology stocks haven`t even begun to selloff, and sometimes the poor performers get hit harder in any larger sector decline.
Hewlett-Packard Company (NYSE:HPQ)
This brings us to our next dead money technology stock in Hewlett-Packard Company (HPQ), which had a tumultuous year with the Mark Hurd saga, a couple of quarters meeting expectations (but not blowing away expectations), and the latest poor year-end guidance due to slower PC sales.

Hewlett-Packard had a nice run under Mark Hurd, and investors who happened to buy into the company beforehand were rewarded quite nicely, but Mark Hurd may have sacrificed longer term growth potential for the sake of a shorter term “Robbing Peter to pay Paul” earnings strategy. He cut costs to the bone (including research and development), and revenue growth through acquisitions, which became earnings drags due to synergistic failures and integration costs down the line.

Click to enlarge
The Mark Hurd era started from such a low base, and investments are as much about timing as anything else... if investors had the foresight to invest in HP in 2002 at $12 a share, then they are not to disappointed with today`s price of $36 a share, although I am sure they wish they would have taken profits at $53 a share.
However, let us not forget that HP was $66 a share in 2000, and those investors are still below water on the timing of this investment. My analysis of HP is that the company has entered the phase of dead money technology firms in 2010, and will likely be dead money for the next five years or longer. From an investment standpoint, this firm's best years seem to be behind it as investors gave Mark Hurd probably too much benefit of the doubt, and have begun scrutinizing the company's results much more thoroughly since his departure.
Currently, HP trades at $36 a share with a 32 cent dividend which comes to an annual dividend of less than 1%. Needless to say, investors are not going to stay in this dead money stock for the minuscule dividend, and it seems that the eight year momentum run period from 2002 to 2010 isn't going to be relived anytime soon.
If my thesis regarding HP is correct, and the company has entered into the dead money investing phase, then the only available remaining investment strategy is to buy the stock at key valuation levels, and sell it when it reaches the top of its trading range. I would wait for the stock to get around $30 a share, it is currently in a downtrend, and as I mentioned-- how much of the current price is still supported by QE2 stimulus of the broader market, and leftover capital allocation of large funds during the Mark Hurd momentum era?
The fact is that with a change in management, this stock is in flux, and has yet to establish its full trading range, and certainly not its lows under new management. I would anticipate being able to pick HP up sometime in the future around $30 a share. Depending if the company can put three consecutive quarters where it beats earnings expectations handily, I would be looking to take profits anywhere from $42.50 a share on the conservative side, to $46.50 on the more aggressive side.
Of course, an investor needs to analyze market conditions and the price action of the stock, if market conditions are favorable and the stock starts to gain momentum, I would re-evaluate my price targets. Maybe take half of the position off if it really starts to gain momentum around $50 a share, and wait and see if the stock can break out of the dead money phase, like Amazon.com Inc. (NASDAQ:AMZN) and International Business Machines Corp. (NYSE:IBM). But I think this is a long shot, and would only be looking to buy HP at extremely oversold levels where I could find relative value, and sell into strength at the top of the trading range.
Apple, Inc. (NASDAQ:AAPL)
This brings me to the most controversial firm in the set of dead money tech companies, in that there is a chance that we gain a new member in the future in Apple Inc. (AAPL). Make no mistake; Apple has not been dead money over the last 10 years, but the phase from 1985 to 1999 was the epitome of dead money. In other words, there might be hope for some of the aforementioned dead money companies. However, Apple is probably the exception, and not the rule. It would be wise to make investment decisions based upon probabilities and the rule.
An investor who bought Apple back in 2003 for $11 a share is doing quite nicely these days, but is it time to take a profit, and look for greener pastures in the form of new growth opportunities?
An analysis of recent price action is interesting, to say the least. After last earnings report, Apple again smashed expectations and analysts all raised their price targets on the stock. But note that even after Apple blew away earnings, the stock was still trading in the exact same area as the previous earnings blowout level, where the same analysts raised their price levels at the time.

Click to enlarge
Apple is always going to blow through earnings expectations because the company guides so conservatively, and the way in which it recognizes revenue gives it a lot of smoothing room. Back to the point at hand-- Apple has gone nowhere for the past four months despite record earnings. In fact, the company is trading in the middle of this recent trading range at $335 a share. The trading range for Apple in 2011 has been approximately $325 on the low end, and $360 on the high end during regular trading hours.
So the question remains: Is the top in place for Apple? It is a great company that has had an unbelievable run of new products from the iPod to the iPad. I guess the questions for investors are:
  • Does Apple need to create another revolutionary product to continue its uptrend or can it stay a momentum stock based upon better iterations of existing product lines?
  • The Steve Jobs factor: How much does his leadership affect the value and future growth prospects at Apple, and can he be replaced?
  • Is competition going to slowly erode Apple's margins in existing products as competitors bring more competitive products online over the next decade?
  • Has Apple run out of areas in its core competency range to be able to innovate?
  • Technology changes rapidly, i.e., Moore's Law: Can Apple stay at the forefront of technological advances and relevancy?
I am not writing Apple off just yet, as the recent price action in the stock could just be an extended consolidation phase before going higher. However, it does seem to need some sort of new catalyst to break out of this current trading phase, and it sure has been dead money for anyone who bought it after each earnings report.

I think Apple will test the low end of its trading range this summer, and we will see if the $325 level holds. My guess is that we will test the $300 a share level once QE2 ends, and asset prices reflect the new monetary environment. Maybe the new iPhone 5 with its reconfiguration will be the next catalyst for taking this stock to the next level, but as of now Apple is on my radar as a potential dead money future technology stock.
Ideally, investors should try to identify what the next momentum stocks are going to be and get them in their portfolio as early on in their run as possible. Nevertheless, it is just as important to identify which stocks are dead money and get them out of the portfolio as soon as possible, as they are just taking up space, and actually losing money when you factor in variables other than a flat trend line like currency devaluation of the U.S. Dollar, inflation effects, and lost opportunity costs.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.